The Pizza Party Isn’t Over for Domino’s

When it comes to picking top CEOs, Domino’s Pizza Inc.‘s (NYSE: DPZ) former head Patrick Doyle often gets left out of the conversation. This is unfortunate considering his record of accomplishment. In fact, since Doyle took the reins, Domino’s shares have increased by approximately 20-fold (1,960%), significantly higher than Apple and Alphabet at 370% and 550%, respectively.

After starting off 2018 with a blistering 50% gain, shares sold off as investors digested results from the recently reported second quarter. Investors were unnerved that comparable-store sales in the international segment only rose 4%, versus expectations of 5.1%. Patient long-term investors should use this opportunity to buy shares in a well-run company.

Image source: Getty Images.

Domino’s is well-situated in pizza

Domino’s stock gains were greatly aided by missteps from other large nationwide chains, particularly Yum! Brands(NYSE: YUM) Pizza Hut, the No. 1 pizza restaurant. Last year the company dismissed calls to divest the struggling brand and instead invested $130 million to grow sales. This year the company assumed the title of “Official Pizza of the NFL” after Papa John’s International (NASDAQ: PZZA) and the NFL ended their longtime partnership.

Per data from Pizza Today, Pizza Hut has been the slowest-growing pizza purveyor among the top four over the last six years, growing gross sales approximately 4.2% per year versus 7.8% for Domino’s. This allowed the latter to significantly narrow the gap between the No. 1 and No. 2 pizza chains.

Data source: Pizza Today. Chart by author.

Papa John’s has seen its once-considerable third-place lead shrink under challenge from a resurgent Little Caesars Pizza, which has more than doubled Papa John’s 7.5% growth rate. More recently, Papa John’s has seen revenue and earnings go the wrong way as the company has struggled in the wake of its messy breakup with the NFL and subsequent controversy.

It’s possible Little Caesars will overtake Papa John’s soon; it may be the biggest risk to the others, because of its massive growth rate and hyper-discounting approach to sales.

The biggest risk is not from restaurants

New CEO Richard Allison faces a different risk than Doyle, and it’s likely the competition will become fiercer. Throughout Doyle’s leadership, Domino’s biggest competitive advantage was its heavy investment in technology, particularly in its app. The former CEO’s approach was best summed up by his comments that “we’re as much a technology company as we are a pizza company.”

Mom-and-pop restaurants — pizza and otherwise — simply could not afford to invest in app technology, and Domino’s nationwide competitors initially failed to see its potential. As a result, Dominos first-mover advantage into the space led to strong growth and customer loyalty.

This advantage is being threatened on multiple fronts. First, nationwide pizza chains have spent significant money on technology, building out their app experience.

Domino’s biggest competitor, however, isn’t another restaurant — it’s the rise of delivery apps like Uber Eats, Grubhub, and Amazon Restaurants. These technology-first companies have partnered with restaurants to provide an out-of-the-box solution that strikes at the heart of Domino’s competitive advantage.

Domino’s is taking the challenge head-on

What’s notable in that in the face of strong U.S. competition from food delivery apps, particularly in the United States, Domino’s continues to post strong growth rates. While the company’s international segment provided lower-than-expected performance, the company’s U.S. same-store sales increased at a rapid 6.9% clip, on par with analyst expectations.

Even with the recent sell-off, shares remain richly valued via traditional metrics, trading hands at 31 times forward earnings, which is nearly double the greater market’s valuation of 17. However, Domino’s deserves this rich valuation, having grown its top line 24% and net income 17% in the prior quarter.

While the competition will only get more difficult from here, Domino’s is well-situated to withstand competition from app-delivery companies while taking advantage of missteps from other pizza restaurants.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Jamal Carnette, CFA owns shares of Alphabet (C shares), Amazon, and Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, and Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.

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