Domino’s Pizza Group: Can future growth justify the current share price?

Domino’s Pizza Group has been a growth monster for most of the past 30 years. Historically it has doubled in size every five years or so and as a result, the shares are currently trading at a premium price.

That premium share price isn’t necessarily a problem though.

If Domino’s can keep doubling in size every few years then the share price will have little choice but to do the same. On the other hand, if that growth fails to materialise, shareholders could be severely disappointed.

Domino’s Pizza Group: A rapid rise to the top

Domino’s Pizza has managed to double in size every five years or so primarily by opening more and more stores which are set up, managed and owned by independent franchisees.

As a franchise business Domino’s can grow without the need for heavy capital investment as franchisees provide the capital required to get each new store up and running.

There are pros and cons to this business model but one thing it does allow is rapid growth, as the chart below shows.

Dominos pizza group financial results 2016 05
An impressive track record of growth

Progress has been both rapid and consistent, with the financial crisis and recession of recent years completely invisible in the company’s results.

My key stats for the company, as compared to the FTSE 100, are as follows:

  • 10-Yr growth rate = 17.5% (FTSE 100 = 1.7%)
  • 10-Yr growth quality (i.e. consistency) = 100% (FTSE 100 = 50%)
  • 10-Yr average profitability (ROCE) = 39% (FTSE 100 = 10%)

During this period the number of Domino’s Pizza stores has gone from 500 to over 900, which means that while the number of stores has been the primary driver of growth, returns per store have also increased markedly (i.e. the number of stores are almost doubled, while revenues, earnings and dividends have quadrupled).

The company has other features which I like, such as a strong brand, market-leading position, little need for capital investment, very little debt and no defined benefit pension scheme.

But beyond that, what I’m really interested in is how long it can keep up that historic record of approximately doubling in size every five years.

Are there limits to how much pizza people will eat?

Currently, Domino’s Pizza has 900 stores, about 90% of which are within the UK with the remainder in the Republic of Ireland and Switzerland.

As a rough comparison, Pizza Hut has 650, Sainsbury 1300, Greggs 1700, Next 500 and Marks & Spencer 850.

With 900 stores, Domino’s Pizza Group in the UK is getting pretty close to the highest number of outlets that any other retailer has managed to achieve.

If it keeps up that historic 15%+ growth rate and doubles the number of stores in the next few years, it will have around 1800 in the UK. That would make Domino’s Pizza outlets about as numerous in the UK as any other national retailer.

Beyond 1800 stores I think it’s likely that the market would be saturated and that new stores would cannibalise sales and profits from existing Domino’s outlet.

From that quick back-of-a-fag-packet comparison I don’t expect Domino’s to achieve much more than one more doubling of size before its UK growth rate drops off dramatically; probably to low single digits.

And even that may be a stretch given Pizza Hut Delivery’s recently announced expansion plans.

So any rapid growth beyond the next doubling will probably have to come from abroad.

The company does already have operations in the Republic of Ireland, Switzerland and a joint venture in Germany, but the scale of these international businesses is nothing like its UK business.

On that basis, I would say that Domino’s Pizza Group does not have any meaningful track record of rapid international growth. They have succeeded massively in the UK, but nowhere else so far (and its expansion into Germany over the past few years could easily be described as a serious failure).

This uncertainty about the company’s long-term future growth prospects is precisely why I’m wary of paying a premium price.

However, at the right price, it’s a company I would be happy to invest in.

A target purchase price for Domino’s Pizza Group

With the share price at 975p, the company has the following valuation stats, as compared to the FTSE 100 at 6145:

  • Dividend yield = 2.1% (FTSE 100 = 4.0%)
  • PE10 ratio = 48.2 (FTSE 100 = 14.4)
  • PD10 ratio = 80.4 (FTSE 100 = 28.6)

The premium share price shows up in Domino’s low dividend yield and high price-to-earnings and dividend ratios shown above (PE10 and PD10 are 10-year versions of the price-to-earnings and price-to-dividend ratios).

That low dividend yield leads to the following unpleasant situation:

If Domino’s did manage to double its revenues, earnings and dividend in the next five years, then its shares would still only yield 4.2% at today’s share price of 975p.

A dividend yield of 4.2% is about in line with the market’s yield, so if Domino’s growth prospects beyond the next doubling are not exceptional, there would be:

  • No compelling reason for the shares to trade at a premium,
  • no compelling reason for the yield the be lower than 4.2% and
  • no compelling reason for the share price to be above 975p.

In other words, today’s shareholders could easily see zero capital gains over the next few years, combined with a relatively meagre dividend income.

Of course, that outcome is based on the assumption that Domino’s growth drops to low single digits after its next doubling of size, but I think that’s a pretty sensible, conservative and cautious assumption.

If one more rapid doubling is all that Domino’s Pizza can muster then I wouldn’t want to pay today’s price.

Another problem is that the current share price of 975p breaks two of my rules of thumb:

  • Only invest in a company if its PE10 ratio is below 30
  • Only invest in a company if its PD10 ratio is below 60

Those rules may seem arbitrary, but they are in fact based on hard-won experience.

Companies which trade on higher valuations than those above are more often than not just expensive, no matter how impressive their growth records.

Taking all of that into account, in order for me to invest in Domino’s Pizza Group I would have to see its share price fall below 700p at the very least.

At 700p its dividend yield would be a more reasonable 3%, while its PE10 and PD10 ratios would be just about acceptable.

Just as importantly, a doubling of Domino’s revenues, earnings and dividend from where they are today would almost certainly lead to the share price climbing higher than 700p, otherwise the yield would reach an unrealistically high 6%.

Of course that’s a hypothetical situation, and to get to 700p in the first place the company would have to run into some obvious problems.

But if the problems were fixable in the short-term and unlikely to damage the company in the longer-term, I think I would be happy to jump onboard at 700p.

Author: John Kingham

I cover both the theory and practice of investing in high-quality UK dividend stocks for long-term income and growth.

12 thoughts on “Domino’s Pizza Group: Can future growth justify the current share price?”

  1. John, I like Dominoes as well and have bought in. I believe it has a moat. It is an international brand of which the UK company owns the overall rights to in UK, RoI, Switzerland and Germany. In Germany, it has just started a 1/3 joint venture to buy the largest pizza delivery chain Joeys. The other partner is Dominoes Pizza Enterprises ( I can’t quantify what this means in revenue/profitability terms but it certainly makes this joint venture the dominant player in Germany. I guess the next step is to re-brand the stores. Then having formed a partnership that makes them more global what other synergies can be made?

    Also, my kids don’t want take away pizza, they want ‘Dominoes’ and when I took my son to university I saw the Hall had a slot full of Dominoes pizza deals leaflets in the reception area. This is for pizza what Coke is for fizzy drinks


    1. Hi Andy, the brand name is definitely its biggest advantage; that and the enduring love that many people have for pizza!

      As for Germany, yes I’m sure they’ll look to re-brand, but slowly and carefully I hope.

  2. Fair amount of competition around now – Pizza Hut, Papa Johns plus others.

    If any recession appears (eg post-Brexit, for instance), consumer discretionary products wil be the first to feel the pinch. One takeaway pizza per fortnight instead of weekly, is a big drop in sales.

    Also earnings growth is slowing and dividend yield is low compared to historical levels. I think the Company will do ok but I don’t see the share price doing much.

    That aside, I wouldn’t touch their pizzas with a barge pole as I don’t like them and the local competition is much better (and cheaper).

    1. Hi Chris, on an anecdotal basis I actually like Domino’s pizza; I’ve always thought they were the best of the takeaway bunch.

      As for recessions, the last one didn’t seem to impact on Domino’s at all. My understanding is that any existing customers who moved to cheaper alternative takeaways or ordered less often, were more than replaced by people moving down from more expensive takeaways or who started eating in more often rather than eating out. Of course future recessions could be different or worse for Domino’s, but I don’t think that’s obviously the case.

      However, I do agree that growth is likely to keep slowing and that from current levels the share price could easily go nowhere for years. Personally I would rather it go down so that I can buy into the company at a more attractive level.

  3. Many valid points raised but your projection is based only on the assumption that a doubling in the number of stores is required to double the share price which, as you stated earlier, has not historically been the case. To assume no future increase in profitability per store and that expansion can only occur in this country is where the argument fails and, most probably, explains why the company is valued at 975p per share and not 770p.

    1. Hi Chris, having looked at it again I think the article is unintentionally slightly confusing around the overall growth rate vs growth in the number of stores. I’ll try to clarify:

      Domino’s has approximately doubled in size (revenues, earnings and dividends) every five years, but the rate of growth of stores is closer to 50% every five years.

      My main point around its growth over the next five years was that even if it doubled in size overall (i.e. revenues, earnings, dividends, etc) then the share price could easily go nowhere.

      I ended up confusing that reasonable estimate of doubling revenues, earnings and dividends with a doubling of store numbers, which hasn’t typically doubled every five years.

      So my position is that the number of store numbers might go up by 50% and that revenues, earnings and dividends might go up 100% over five years, which could easily lead to the share price going up 0% from where it is today.

      Of course there is then another 50% of growth left in the number of stores before the UK is saturated (obviously it’s much more vague than this in reality), which someone might then assume would lead to yet another doubling of revenues etc. if returns per store keep going up.

      The counter argument is that returns per store cannot keep going up as such a rapid pace. While it might be easy to double revenues or profits per store from a low base, there is only so high that they can go and growth will slow as output per store moves towards some physical maximum.

      As for the current price, I would agree with you: The price is probably where it is because other investors are more optimistic about Domino’s growth potential both within and outside the UK than I am.

  4. John, I like the article but I need just to point out few things about Domino’s business model.
    1. Brand is rarely a competitive advantage. Pizza hut is better known thatn domino’s but Pizza hut is going backward. Domino’s has been an amazing user of technology and this what alls to defeat competition because they can deliver the pizza in the fast way as possible.
    2 the pricing power (domino’s is the most expensive pizza). although they stop growing in UK they can still grow at an inflationary rate (2 3%) raising the prices.
    3. Domino’s has a “moat” through economy of scale on the supply chain. Spreading the overheads they are able to increase the profit marging year over year (the more profitable the more attractive it is)
    4. Let’s not consider the growth in Germany but only the one in UK. UK market is underpenetrated compared to US or Australia where there are other two Domino’s Pizza. Urban population per store is 51K in US, 36K in Australia and 61K in UK.
    5 Regarding the evaluation it always had this multiple over the past 10/15 years delivering excellent return. Shareholder returns of the last years (that is less than at the beginning because it is a mid cap now) is 16% annualized dividend reinvested.



    1. Hi Paolo, thank you for sharing those points; very interesting and provides a bit more detail about how Domino’s operates.

      I think for the most part your points confirm my assumption that Domino’s is the best pizza delivery operator in the UK and also that the UK market is getting close to saturation, with perhaps no more than one more doubling of the number of Domino’s stores over the next decade. Beyond that point growth will likely be single rather than double digit, with lower valuation multiples being more appropriate as well.

  5. John — Not sure if this has been mentioned in the above comments, but the corporate company Domino Pizza is listed in the US and the UK listed company is a completely seperate entity.
    Interesting that this was Terry Smiths darling company that he kept using as his benchmark for a great brand, high ROCE (because it has low capital base via franchises) etc.
    All of a sudden a few months back Terry dumped it, with no real explanation other than he couldn’t see enough available stock to buy at the right price — in other words it’s too darned expensive.

    This goes against his buy and hold mantra, but underneath it all I suspect they have seen something they don’t like.
    Domino in the UK went about 4XX not too far back and it could revisit that. It has failed to take off in Germany and you are probably right to be a bit wary about the growth potential in the UK. Given that the Corporate company controls the brand/franchise for the rest of the world, I wouldn’t buy the UK company at all, it would have to be in the US — but I personally have always found the Pizza’s to be ridiculously ovepriced and they only ever seem to sell them as two for one’s or heavily discounted. Not a fan of that false approach.

    Interesting John, have you done a similar eyeball over IHG as this is focussed on the franchise hotel business with the added bonus of selling off hotels every now and again to hand back cash to shareholders. It’s on Richard Beddard’s list of value stocks, although I don’t know how to value IHG — it looks expensive on first glance.
    It’s recently moved back into Fundsmith’s top 10


    1. Hi LR, yes, perhaps I should have made that a bit clearer: The US company is THE Domino’s pizza company, while the UK company simply owns the UK master franchise and therefore the right to use the name, logo, processes etc under license from the US company.

      I think Smith sold primarily because of valuation factors. Although he’s buy and hold he has said that he’ll sell on occasion if a) an existing holding is way overvalued and b) if it can be replaced with something better/cheaper.

      As for the pizzas I don’t eat any meat/dairy stuff anymore so I can only comment on what they were like five or ten years ago, but back then I thought they were a nice expensive treat, but if I wanted a cheaper alternative then my local kebab place would do one for about half the price (and half the quality!).

      IHG (InterContinental Hotels) I know nothing about. A quick glance shows it at 153 out of 240 companies on my stock screen so not obviously good value. The company’s results look ‘okay’ but the price seems a little lofty for my taste. That’s with a ten second analysis though, so not very thorough!

  6. Another nagging doubt I have about investing in Dominos and other fast food companies, is Britain’s growing obesity epidemic.
    We have recently seen the sugar tax on fizzy drinks introduced in the last budget, although not scheduled to take effect just yet. There are a couple of high profile US hedge fund managers criticising Coca Cola and Pepsi about the health risks and one has just sold its entire stake in Pepsi.

    Recognising that people will often buy fizzy drinks when they buy fast food and so price increases for the the fast food ‘experience’ will be larger than they otherwise would be, I can’t help feeling that mass-produced processed stodge like pizzas and burgers are going to come into the firing line of the health lobby and the exchequer sooner or later. And not before time, some people might say.

    1. Hi Chris, yes totally agree with that. A food ‘fat tax’ is a serious possibility, plus fat and calorie information becoming ever more prominent. It’s a risk factor but impossibly to quantify in any meaningful way, so for now I’m aware that there is a risk but am choosing to ignore it – for now.

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