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Morningstar | Third-Party Aggregators Eat Into Domino’s 2Q Comps, but We’re Optimistic About a Reversal in 2020

Wide-moat Domino’s second quarter was largely a continuation of early 2019 trends, with U.S. comps pressured by marketing/promotional tactics from third-party delivery aggregators as well as its own fortressing strategies and tight labor markets having a ripple effect across pricing strategies and margins. While we surmise these trends will persist through the back half of 2019, there are reasons to expect gradual comp improvement in 2020 and remain optimistic about the longer-term free cash flow profile.

Most of the focus coming out of the quarter is on domestic comps, which at 3.0% was at the low end of management’s three- to five-year outlook of 3% to 6% and below our 5% estimate for the year. While we don’t expect third-party delivery marketing/promotional efforts to subside the next two quarters--and plan to adjust our full-year domestic comp expectations to roughly 3%--we identify three factors that support a potential reversal in 2020. First, as the third-party delivery category consolidates and certain exclusivity arrangements end, we think reduced promotions from second-tier aggregators will result in more rational delivery pricing. Second, we expect Domino’s technology efforts--including a loyalty member base of 20 million following the recent Points for Pies program, the launch of GPS tracking technology by year-end, and brand awareness from the Nuro self-driving delivery tests in the fall--will drive a modest uptick in transaction growth next year. Finally, we believe Domino’s franchisees are getting ahead of minimum wage increases--the 3% U.S. comp increase was largely ticket-driven--which should minimize crew/driver attrition.

There is no change to our $275 fair value estimate (our adjusted 2019 comp outlook will be offset by the time value of money) or our long-term outlook (average annual global retail sales growth of 9% and 19% operating margin over the next 10 years). After the high-single-digit pullback, we view shares as a bit undervalued.

On the international front, comps continued to lag at 2.4% in the quarter, below our full-year expectations of 3%, as foreign currency headwinds and market-by-market issues plagued results. While comps leave much to be desired, we contend Domino’s is taking the right steps by meeting with all master franchisees in June 2019 to share best practices from the U.S. and other leading markets. The U.S. has used a simple playbook of increasing store density while offering a consistent price for its food to drive transactions thus lowering the marginal cost per delivery, and we see no reason why this would not translate successfully across borders. For additional insight regarding Domino’s largest international master franchisee--Domino’s Pizza Enterprises--please see Morningstar’s recent report, “Check Out the Deal On Domino’s Pizza.”