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DPZ’s comments were in line with what we heard from the company last week when it reported 4Q09 results.  The company maintained its optimistic tone and reiterated that current sales are up significantly following the late 4Q09 launch of its “new and inspired” pizza.  Relative to DPZ’s competitors, management made two interesting comments.  First, DPZ said that the pizza category is now growing and is up 5%, but the company does not know yet how much of the growth is driven by DPZ versus its competitors.   DPZ’s “significant” pickup in quarter to date sales trends most likely does not bode well for Pizza Hut from a market share perspective. 

Second, DPZ stated that it will be interested to see if it is stealing share from the frozen pizza category.  Management said that although the frozen pizza category is seeing growth in its average ticket, it is not experiencing growth in the number of people buying frozen pizza.  With DPZ now selling pizza at lower price points than some of its frozen pizza competitors, it could take share.  This is a potential negative for CPKI.

Notes from the presentation:

Pizza  - Great category rooted in family tradition:

  • 1 trillion in food industry
  • 33 billion is pizza

DPZ-specific:

  • Delivery and carry out
  • 45% of sales are international
  • In over 60 countries

Average check for party of four eating QSR pizza is $22.54 vs. $49.94 at FSR

“New and Inspired” Pizza product

  • Months of consumer trials have gone on
  • Very pleased with the launch of this product
  • Sales are up significantly but we have not quantified that as yet

#1 delivery company

  • Small chains and independents make up 55% of market share
  • DPZ 18%
  • Other 2 national competitors make up 27%
  • Great growth opportunity
    • 20% of sales comes from online ordering
    • Technology is a very important part of the delivery business’ future
  • Margins grew last year largely due to commodities and new efficiencies

Business Units

  • Domestic stores
    • 4,461 Franchised stores
    • 466 domestic stores
  • Domestic Supply chain (partnership with franchisees – 50%of profits)
    • 17 dough manufacturing facilities
    • One equipment and supply facility
  • International
    • 4,072 Franchised stores
    • No Company-owned stores
    • 6 dough manufacturing and supply chain facilities

Domestic Franchisees

  • Strong business partners with long term partnerships and high collection rate
  • Owner-operators with no outside business interests
  • No significant concentrations
    • 1,200 franchisees owning 3 or 4 stores on average

Unit economics

  • Low cost to open/operate – 150-200k for new store
  • Cash on cash returns in 30-40% range

Commodities

  • Cheese is the most significant aspect
  • Cheese prices anticipated to be in 1.50-1.70 range, as per earnings call, but prices going down (only 1.27 yesterday)
  • Rolling over low prices from 2009 but hopefully, we will be surprised

International profits are driven by franchise royalties

  • 91% of 2009 international operating income
  • International represented 34% of total DPZ operating income in ‘09
  • Significant international growth in 2009
    • Global Retail Sales CAGR of 12% from 2004 to 2009

Capital Structure

  • $1.5 billion of debt
    • 6% blended cash interest rate
    • Interest only with 2 one-year extensions on top of 5 years  -through April 2014
  • 6-7x leveraged now. Intend to be in the 3-4x range by refinancing time.

Positive EPS trends

  • In 4Q09 delivered 35 cents (30 cents normalized for extra week) vs. consensus of 25 cents

Long range outlook:

  • Domestic SSS: +1% to +3%
  • Int’l SSS: +3% to +5%
  • New Units: 200 to 500 globally
  • Global Retail Sales: +4% to +6%
  • Normalized Annual Cap-Ex: $20 to $30 million
  • Tax rate: Approximately 39%

Use of cash

  • Capex is being used to deleverage
  • Pay significant dividends
  • Repurchase shares

Important points from Q&A:

Q: Promotional environment? Franchisee financing? Small franchisees?

A: Promotional market is competitive between PZZA and DPZ. 80% of all pizza sold is on deals. The consumer has always been looking for deals when they decide where to get pizza.

Small franchisees have not been as forthcoming, still tight. Well capitalized franchisees still coming forward.

Q: 80% of menu is new…what’s next? Additional product?

A: Continuing to offer promotions but want to make sure that people try the new pizza product we just rolled out.

Q: Domestic franchise growth and why it has grown over past 5 years?

A: DPZ has 1,000 stores we could open domestically…not saturated market.  Harder to find growth opportunities than before.  We know growth is there. Once the credit market opens up that will help.  Franchisees were hurt badly in ’08 by commodities and prices had come down in ’09. So we need to make sure unit economics are right and we can attract the right franchisees.

Q: PZZA said that the pizza market had gone from 5% decline to 5% growth. Where is the share coming from?

A: Pleased to see pizza category up, we get the same data. We don’t know how much of the 5% of growth is ours vs our competitors.

Q: Growth in online business.  Logistically, what are the pluses and minuses of the online stuff?

A: Now 20% of sales, and expect it to continue to grow.  Corporate stores are leading  the way with this with higher ROI.

Gets a menu in front of the customer.  Tracking mechanism.  Good website. Less labor involved. Very efficient.

Q: Frozen pizza competition?

A: Frozen is growing but most recent data shows that the ticket is growing but the number of people that is buying the pizza is not…I’ll be interested to see if we are taking share from the frozen pizza companies because some of our pizzas are priced lower than some frozen pizzas options.

Q: Shift in TV advertising. Is this the highest level? What is driving it?

A: In 2008 we moved money to coops from national advertising and that was a mistake. Went back to franchisees and they agreed on 5% for 2009 for national advertising.

Now rolling up to 5.5% (with unanimous support from franchisees)

Q: What kind of pathway do you think we can expect from new pizza? What date will you give us data on? When will business tend to trend down?

A: It can taper off within days or it can taper off within a few weeks…end of December was very strong when the “new and inspired” pizza product was launched. Promotions typically taper off, but this is not a promotion.  We have completely revamped our core product and we have no history with revamping a core product to measure current performance and if can be sustained.  Reported trends will come with 1Q earnings on May 4th.

Howard Penney

Managing Director