Pizza maker has growth ingredients

Domino’s Pizza has delivered great returns … and there’s more to come.

Summary: Domino’s Pizza’s management discovered the recipe for growth by developing a model that extracted maximum value from deliveries, and incorporating internet ordering. Extra margin has been added recently by lifting the price of its core products.
Key take-out: Domino’s is a high-quality business that has positive earnings momentum and very attractive economics.
Key beneficiaries: General investors. Category: Growth.

I think 2013 will be another year that demonstrates buying high-quality businesses – those with the lowest risk of catastrophe and bright prospects for intrinsic value growth, at a meaningful discount to intrinsic value, will outperform the broader market.

To do that you need to buy businesses rather than trade stocks. In turn, to achieve that, you need to think about businesses and the characteristics that differentiate the great ones from the mediocre.

The success of Domino’s Pizza has been remarkable – the company has grown earnings per share by 32% annually since 2004. Success like this rarely goes unnoticed at Montgomery Investment Management. With its half-year results just around the corner, here’s an insight into why consumers have had the ‘hots for what’s in the box with the dots’ for so long. More importantly, I’m wondering what rabbit management will pull out of the pizza box to sustain this growth.

Domino’s is a company that has revolutionised the way pizzas are sold. Who would have thought there could be so many ways to re-invent the wheel? Many initiatives have been driven by the Lamborghini driving CEO, Don Meij, and those initiatives were often met with scepticism from stakeholders before they realised the value of his vision.

Management became aware very early on that the best margins for the pizza business were through deliveries. People were willing to pay a premium for the convenience of pizza delivered to their door, and management have been very efficient with this business model extracting every cost saving possible from low fuel consumption delivery vehicles to competitive pay rates on holidays for delivery contractors.

One of the biggest calculated risks management took, however, was expanding into Europe when the GFC and European crises were unfolding. The company was able to successfully adapt its business model to the European market, which is now a core growth engine, returning earnings before interest, tax, depreciation and amortisation growth of 68.1% in 2012.

Another of Domino’s core competitive advantages is its adoption, customisation and application of technology. It now has seven online platforms that consumers can use to order pizza. Online sales provide very attractive margins – not only because costs are lower but users can spend up to an estimated $6 more ordering online than via telephone or in-store.

So pervasive is Domino’s digital innovation that 50% of sales in Australia and New Zealand are now over the internet.

The company is also very focused on the quality of its pizzas. Management became quite concerned about the risk of a fat tax being implemented in Australia. It has since invested heavily to ensure that its pizzas are of a high quality – it sources fresher ingredients, has lowered the fat and sodium levels in its food, and caters to a wide range of dietary requirements including gluten-free products. This is all done through a central product laboratory that handles the menu for all of its stores around the world.

Domino’s has recently refurbished its stores with a focus on bringing the pizza-making production line (the ‘makeline’) in front of the customer. It is said that consumers have a greater level of trust for brands where the product is made before their eyes – this is why Subway, for example, enjoys high brand loyalty, trust and power.

So all in all, it’s clear to see Domino’s has become the dominant force in the pizza industry and a beacon for retailers seeking to enter and the leverage the internet sales revolution. But what’s next? What areas or markets is management targeting to support the company’s stellar growth and share price?

Management could make its next big strategy providing a gourmet-range at reasonable prices. Domino’s has previously introduced a gourmet pizza selection to gain market share from higher-end chains like Pizza Capers. While initial sales were always promising, they were never sustainable and dropped off after a couple of weeks. In addition, this strategy will result in a battle for market share rather than defining a new market. Domino’s has been successful largely because of its ability to establish new markets and earn attractive margins before competitors could catch up. It’s much harder to enter a well-established market and reclaim market share – just look at how Apple is shifting its business model in an attempt to regain market share from Samsung and the impact that is having, particularly on its image as a design innovator.

Domino’s has also tried to provide a lunch range, but to no avail. Does anyone remember the oven-baked sandwiches? Perhaps the company is reaching a mature phase of growth with its core products.

In the meantime, what the company has been able to do is increase the price of its core products. And this is a reflection of the most valuable competitive advantage. The company has recently increased its ‘Cheap Tuesday’ prices by $1. The price of a pizza in the value-range has increased from $4.90 to $5.90, while the price of a traditional-range pizza has increased from $6.90 to $7.90. This is what I like to see with quality businesses – management that can increase prices while maintaining turnover will see the increased margins flow directly through to the bottom line. In saying that, the price increase of around 15% is also considerable, and it will be interesting to see how an increase of this magnitude will affect sales.



Ultimately, Domino’s is a high-quality business that has positive earnings momentum and, more importantly, very attractive economics. For the moment, however, the share price remains at a premium to intrinsic value. Current prices notwithstanding, Domino’s is being run by a very effective management team. I love a fast boat with a great skipper. But I also want a bargain.


Roger Montgomery is the chief investment officer at Montgomery Investment Management. If you would like the opportunity to discuss your portfolio and investment options with Roger or his team simply email office@montinvest.com.