Jim Cramer, of CNBC fame, has an interesting thesis on Domino’s Pizza Inc. (DPZ, Financial): He thinks it is a tech company. Evidently, he has decided that is the only way to justify the pizza delivery company’s eye-watering valuation multiple. But there is just one problem: Domino’s Pizza is not a tech company by any meaningful definition, and it certainly does not deserve a tech stock valuation.
Cramer’s mad idea
Cramer debuted this idea in May and repeated it again on an Oct. 16 segment of “Mad Money” in which he discussed Domino’s advances in technology with CEO Ritch Allison. According to Allison, Domino’s is at the forefront of artificial intelligence and self-driving technology:
“Autonomous vehicles are certainly one thing we’ve been working on. We talked to you in the past about DOM, our artificial intelligence natural voice system. We’re still piloting that in some of our corporate stores. It’s learning, it’s growing, it’s getting better. You know, we announced on the call this morning we just recently rolled out within our stores a voice inventory app that our team members can use for one of the most unpleasant tasks they have, which is, at the end of a shift they’ve got to go count the food that we have in the walk-in cooler. This makes that job easier and faster for them.”
So apparently Cramer thinks this is tantamount to being a tech company. That is a gross misinterpretation of how technology works.
The big mistake
Let’s take a look at these technologies Domino’s is rolling out. We can set the inventory app aside immediately; they are a dime a dozen and offer no meaningful benefit to Domino’s bottom line in terms of a saleable product. Additionally, the natural voice artificial intelligence interface is far from unique; and again, it is purpose-built for Domino’s, not to sell to other companies. By the company’s own admission, it is simply building its own version of a technology that is spreading across numerous industries. It seems as if Cramer is the only person who thinks Domino's has the versatility
As for autonomous driving, again Domino’s is not in the race. It has partnered with Ford (F, Financial), which is developing its own autonomous driving technology in competition with Alphabet Inc.’s (GOOG, Financial) Waymo and General Motors’ (GM, Financial) Cruise systems. While Ford is seen as a potential competitor, it is still considered to be behind these two. As for Domino’s, it is just a test partner for Ford.
And there lies Cramer’s fatal error: He sees Domino’s adopting and experimenting with new technologies and concludes that it will be able to sell those technologies. But that is simply not true. In the case of the AI and apps, they are designed for company-specific purposes and have no real utility for other applications compared to the likes of Amazon’s (AMZN, Financial) Alexa. As for autonomous driving, the technology belongs to Ford. Whatever slight advantage Domino’s might hope to have by being at the cusp of testing this technology, it would prove totally ephemeral as other pizza chains license the exact same technology from the real owners of the tech.
A problem of valuation
What really seems to be happening is Cramer is trying to talk himself into a mindset that can justify Domino’s current valuation. But that makes little sense. While earnings did rise substantially in the third quarter (up 65% from 2017), same-store sales disappointed to the downside, having grown by just 6.3% in the United States and 3.3% in international markets.
Domino’s has a network of 5,751 stores in the U.S. and 9,603 stores spread across 85 international markets. The problem facing the company is that its valuation assumes massive and sustained growth.
But here’s the rub: The market may already be nearing saturation point. With limited room for sustained growth by means of new store openings, same-store sales will gain increasing importance. But same-store sales growth is not nearly sufficient to justify a price-earnings ratio of 36.
Verdict
The simple fact is that Domino’s is not a tech company and should not be valued like one. It is a pizza company. That has been, and will always be, its core business. So we have to judge Domino’s by the performance of that core business, not some pizza pie in the sky notion of tech development.
Domino’s Pizza probably does not deserve its current valuation. It is unclear, however, when the market will realize that.
Disclosure: No positions.
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