Domino's Pizza Group: An international brand on a budget

According to Terry Tanaka, the Domino's Pizza Group's problems appear to be cyclical rather than structural

For shareholders who have stayed with the company for the past 15 years, Dominos Pizza (Nasdaq: DPZ), the US division of the international Dominos brand, has been an excellent investment. Over the previous 15 years, the stock has produced a total return of 27.1% annually, surpassing the benchmark index's 14.4% return during the same time frame, according to data compiled by Morningstar.

Domino's has a straightforward business strategy. It uses a vertically integrated supply chain and cutting-edge technology to support its "asset-light" franchise model. The majority of its revenue is derived from franchise royalties and sales proceeds from its supply chain network. A highly cash-generative business model results from this.

Just £31 million of the £625 million in operating cash flow that Dominos produced last year was reinvested in the company. The management has long employed this strategy, using almost all of the remaining funds to fund the dividend and buy back stock. Buybacks of shares have nearly doubled the growth in earnings per share over the last five years.

Domino's Pizza Group is having problems.

Regretfully, Dominos Pizza Group (LSE: DOM), the UK division of Dominos, has failed to match the success of its much bigger US-listed competitor. The stock fell to a 10-year low earlier this month.

Earnings were two-thirds of what they are today, and the number of shares was 100 million more than it is now, when the shares were last trading for 200p. This suggests that something has gone very wrong. December 2021 saw the stock reach its highest point ever, over 450p. It's been on a roller coaster ever since, with the current decline beginning in 2023. Since then, it has lost half.

The current CEO's appointment, Andrew Rennie, who joined the board in August 2023, is the root of the company's problems. After Rennie joined, it became clear that the group was trying to expand Dominos UK's empire by acquiring a second fast-food chain.

The business thought it could use its size and experience to turn a new brand into a powerful force that would rival Domino's nearly 60% market share in the UK pizza industry. The search for a second acquisition is starting to seem like management has lost focus.

The group announced a significant profit warning at the start of August, stating that it was reducing its 2025 profit forecast by 12% because of a "tougher operating environment." Fuel was added to the fire by a drop in flat total orders and like-for-like sales.

Cycles.

However, rather than being structural, Dominos' problems seem to be cyclical. The company still generates a lot of cash, and even though growth has slowed, customers are still devoted.

For example, the trial of its loyalty program is doing better than expected. Recently, management announced plans to buy back £20 million from shareholders. Panmure Liberum estimates that this amounts to roughly 2 point 6 percent of the share capital and could result in a 12 point 6 percent rate of return, which is equivalent to a 2 point 6 million increase in annual profit.

According to Panmure Liberum, the rate of return increases to over 13 percent if Dominos returns more than 50 million.

The company would be better off using its money to retire shares than to buy out other companies at this rate. In the most aggressive scenario, according to Panmure Liberum, Dominos can spend 219 million by 2029 paying back stock using both debt and free cash flow from operations, or about a third of its current market value, if it uses leverage up to the upper end of its target (2 points five times earnings before interest, tax, depreciation, and amortisation). That is exactly what activist investor Browning West is pushing for.

Domino's Pizza Group: the conclusion.

With 5% of the company, Browning West is one of the biggest shareholders. Usman Nabi, Dominos' founder and chief investment officer, recently wrote to the company requesting that it "immediately begin a significant share-buyback program of at least 100 million to be completed before year end and pause any contemplated acquisitions for six months."

He explained that this strategy would be the most advantageous for the business because a big deal would require a lot of time from the senior management team and carry significant risks for the company. He made the case that concentrating on the group's present activities and expansion would be preferable.

It's not always good news to have an activist at the gates, but in this instance, it might be the push the board needs to take a different course. The 20 million buyback that was just announced is encouraging and should yield strong cash returns.

Following recent drops, the stock is now trading at one of the lowest valuations in recent history, making it appear incredibly inexpensive when compared to its global counterparts. Dominos offers the unique combination of a powerful brand at a low cost.

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