2010 was an exceptional year for DPZ. 2011 will likely not be as impressive, however, given higher commodity costs and tough comparisons from a top line perspective. Management knows the company’s YOY momentum will slow in 2011 and, accordingly, cautioned investors to not focus too much on YOY comp growth as the company laps the strong performance from 2010. Specifically, management said it expects to post a negative sales comp in 1Q11.
Comparisons get a little easier during the balance of the 2011 after lapping the initial trial period around the launch of DPZ’s new and improved pizza in 1Q10, but they remain difficult. Although management did not comment on its same-store sales growth expectations for the remainder of the year, it is important to note that if two-year average domestic company-owned comp trends stay flat with 4Q10 levels throughout 2011, it would imply a -3.4% comp for the full-year. Even if two-year average trends accelerate from here, same-store sales growth will slow meaningfully on a one-year basis. I am currently modeling flat comp growth for FY11, which assumes a quarterly decline in both the first and third quarters.
Rather than comp growth, management directed investors to focus, instead, on overall volumes and profitability. Nevertheless, I have my concerns about DPZ’s profitability in 2011. DPZ achieved margin growth in 2010, despite the 16% increase in cheese prices. Cheese prices moved straight up, but so did comp growth. Cheese prices will move higher again in 2011, up 13-17%, based on management full-year forecast of $1.70-$1.75 per pound. The company guided to a 3-4% increase in total commodity costs in FY11. For reference, DPZ does not lock in any portion of its cheese needs but has a contract in place with its supplier that allows the company to reduce the impact of cheese market price volatility by approximately one third. Outside of chicken, the company has not locked in any of its other meat needs.
The expected 3-4% increase in commodities assumes cheese prices ease from their current level of nearly $2.00 per pound so there is risk to management’s current expectations. Either way, DPZ contended with higher cheese prices in 2010 thanks to elevated domestic company-owned comps, which increased 9.7%. In 2011, however, cheese prices will continue to move higher as comp growth moves lower. Both store-level and supply chain margins will take a hit from the expected 13-17% increase in cheese prices (could prove conservative) as same-store sales and volume growth moderates significantly and potentially turns negative.
Management said that they have not yet decided whether to take price in 2011 given that consumers still want value, but commented that a 1% price increase would be necessary to offset a 3-4% increase in commodities. The company also highlighted that some of its QSR competitors are starting to take price now, “but with the sorts of increases [they] are looking at right now, you are not looking at a big issue at this point.” I have to disagree with this point because, as I said earlier, the expected 3-4% increase in commodity costs could prove conservative and any price increase in this environment will likely take a toll on traffic, which could turn into a big issue for DPZ when you consider the level of traffic gains the company is lapping in 2011.
Howard Penney
Managing Director
