THE HEDGEYE EDGE
For the better part of the last decade Domino's Pizza (DPZ) has operated in a world of its own, dominating the pizza and broader food delivery environment. DPZ was the first-mover when it came to technology-assisted pizza delivery services and because of this, independent pizza shops, Pizza Hut, and other restaurants have not been able to adequately service the delivery market. However, competition is heating up.
Competitors Are Revving Their Engines
DPZ's success has come at the expense of independent pizza shops, Pizza Hut and other restaurants that have not been able to service the delivery market.
We have begun to see evidence of the competition for share of delivery spending hit the Domino’s UK business, which we believe was the primary reason for their shortfall in 2Q17. The UK is a far more developed delivery market than the U.S., but domestic players are catching up.
With the help of UberEats, DoorDash, Postmates, and even restaurants delivering for themselves (Panera), restaurants of all different cuisines are getting into delivery. This dynamic, coupled with resurging Pizza Hut (this may finally be their moment), could be enough to stop DPZ’s reign.
Short Domino’s Globally
As we have been alluding to for quite some time, the United States’ delivery landscape lags behind that of other economies across the globe, most notably the UK. Our research regarding Domino’s UK business led us to the discovery that the UK business was not only the portion of the Company feeling the squeeze. The slowdown can be seen in the SSS metrics for the Japanese, Australian and EU (ex UK) portions.
Most recently, Domino’s Pizza Enterprise (DMP.AU) reported FY17 financials and results were very disappointing, missing upgraded guidance figures. If DMP.AU is a glimpse of what is to come across the broader Domino’s business, we can expect to see other dominoes fall as competitive pressures continue to encircle the brand.
Financial Engineering Is In The Past
In 2015, the Company announced an $800 million repurchase program, which replaced its previous $200 million program. As part of the authorization, the company conducted a $600 million accelerated share repurchase. More recently, DPZ returned $22 million to shareholders in 2Q17 in the form of a $0.46 per share quarterly dividend, and closed a recapitalization transaction on July 24th, 2017.
According to the Company, the interest rates they will be paying on this new debt are favorable, however, we believe that, going forward, if DPZ were to continue to execute on this type of financial engineering in a rising rate environment, it would not be as fruitful. Then on August 2nd, 2017, the Company entered into another $1.0 billion accelerated share repurchase agreement and will acquire shares as part of its new $1.25 billion share repurchase program. This aggressive effort to increase shareholder value is now in the rearview and DPZ will now be forced to increase shareholder value by driving top-line growth.
DPZ is growing units too fast in our opinion, and as sales have slowed, and can slow further with the rise of delivery competition, franchisees will be less inclined to open new units which will crack the growth story for DPZ.
We believe the next 6-12 months will be a rocky road for DPZ as their international franchisees are struggling, and problems are brewing in the U.S. We see -40%+ downside in shares of DPZ from current levels.