Domino’s Pizza Inc. (DPZ, Financial) is the dominant player in the American pizza business. As the company noted in its 10-K for 2021, “we are the dollar market share leader for delivery and a growing leader in carryout.”
The GuruFocus GF Score is a very high 92 out of 100, due partially to its 10 out of 10 scores for profitability and growth. It also scores an 8 out of 10 for value.
But about that debt…
Should this chart of cash and debt scare away investors?
About Domino’s
Founded in 1960, the company has become a leading light in the pizza and quick-service restaurant sectors. In 2021, it generated revenue of $4.36 billion from more than18,800 stores in at least 90 countries. Its biggest revenue source is its supply chain, which supplies products, including dough, to the stores.
As it noted in its 10-K:
“Domino’s generates revenues and earnings by charging royalties and fees to our independent franchisees. We also generate revenues and earnings by selling food, equipment and supplies to franchisees, primarily in the U.S. and Canada, and by operating a number of Company-owned stores in the U.S. Franchisees profit by selling pizza and other complementary items to their local customers.”
Competition
At home, Domino’s competes with national chains as well as regional and local operators. The big four of the pizza business are Domino’s, followed by Pizza Hut (owned by Yum Brands (YUM, Financial)), Little Caesars and Papa John’s (PZZA, Financial).
On the international front, it competes with Pizza Hut and Papa John’s, as well as country-specific national and local pizzerias.
The only other pure-pizza chain that is publicly traded is Papa John’s and it has a cash-to-debt chart that looks like that of Domino’s. The same holds for Yum Brands, although it is more diversified, with a stable that also includes KFC and Taco Bell.
Essentially, then, high debt is generally a characteristic of the pizza business, at least for the big chains.
Financial strength
The table above, with a lot of red and yellow bars, indicates that debt could be a serious problem for Domino’s. We might even be tempted to think that a 4 out of 10 ranking is generous for this much red and yellow.
However, when we get to the bottom of the table, we see a robust WACC to ROIC ratio. Its weighted average cost of capital is 5.16%, while its return on invested capital is 52.04%
That’s slightly better than a 1 to 10 ratio, or to put it another way, for every $1of equity or debt, it generates $10 dollars of return. That has to be one of the highest and best ratios in any industry.
Papa John’s and Yum also have strong ratios:
- Papa John’s: WACC of 8.39% versus ROIC of 21.89%.
- Yum: WACC of 9.48% versus ROIC of 41.16%.
What do these companies have in common that makes them so profitable?
They all use a franchise model that puts most of the capital requirements on the franchisee’s tab. Then, once a franchisee joins Domino’s, it must buy most of its supplies through the parent.
The Bain connection
In 1998, founder Tom Monaghan wanted to get out of the business and pursue other interests. He found a buyer in Bain Capital, which purchased the company using more than $700 million of debt financing.
To repay that debt, the company has recapitalized its debt several times. In addition, some of the debt was used to finance its growth, helping to push up its total indebtedness.
This chart shows how it has grown:
Domino’s went public in 2004, which is the year the debt dropped off temporarily.
Short-term debt is not a concern. At the end of March, it totaled $56 million, compared to $5 billion in long-term debt.
What does management think?
While management does express concern in the risk factors section of its 10-K, its actions indicate comfort with the debt load. For example, it has significantly increased its dividends per share over the past decade:
It also has trimmed the number of shares outstanding:
In 2021, Domino’s directed $1.46 billion toward buybacks and dividends ($1.321 billion and $139.399 million, respectively).
That’s significantly more than the $910.212 million that went toward its long-term debt and capital lease obligations.
What should investors think?
A company’s ability or inability to make interest payments is at the heart of investor concern about debt. Far too often, investors have seen their once flourishing companies go bankrupt or be swept away at ridiculously low prices because of debt.
Is Domino’s at risk? There are several reasons to think it is not.
First, it has moats that allow it to maintain its profitable pricing. It literally has the secret sauce for a successful pizza or QSR business. For more than 40 years, customers have bought its products in sufficient numbers to keep it growing.
Closely connected with the secret sauce is the company’s brand. It encompasses not only the secret sauce, but also the technological and logistical expertise behind its delivery and takeout businesses.
Then, there’s the well-tuned infrastructure that produces and delivers supplies to individual restaurants. Supply brought in more than $2.5 billion of 2021 revenue.
As long as Domino’s retains these competitive advantages, it should have no trouble maintaining its profitability (and ability to repay its debt).
Second, the company generates ample free cash flow. For 2021, net cash from operating activities totaled $654.2 million. After deducting $94.17 million for capital expenditures, it was left with free cash flow of $560.03 million. As the trendline in the following chart shows, free cash flow has grown by an average of 16.65% per year over the past decade:
While free cash flow doesn’t necessarily go directly into debt repayment, investors know that if the company ran into trouble, it could tap into a lot of cash by suspending dividends and share repurchases for a year or several years.
Finally, the company has a long-term, major investor. Guru Bill Ackman (Trades, Portfolio) has made a major commitment to Domino’s. He owned 2,092,202 shares at the end of 2021 according to 13F filings, representing 5.81% of the company’s shares outstanding and 10.95% of Pershing Square’s assets under management.
Conclusion
There’s no arguing with the debt level at Domino’s Pizza. It’s high and should concern any strict value investor.
However, more flexible value investors and growth investors might look at some of elements behind the debt. In particular, they should note management is highly effective at turning capital (including debt capital) into profitable growth. We’ve also noted many other reasons why investors should not be scared away by the debt number in isolation.
This is a strong, growing and profitable company, and should stay that way for at least the next five to 10 years.
