Why Domino's Pizza Has No Fear of Rising Cheese Costs

Commodity prices are through the roof! Does Domino's Pizza care? Nope.

Aug 10, 2014 at 9:00AM

Dpz
Source:  Domino's Pizza.

Costs for cheese, meats, and other toppings have been rising faster than thick-crust pizza dough in a 500-degree oven. Despite the higher food bills, shareholders of Domino's Pizza (NYSE:DPZ) continue to see their slices of the company pie climb to mouthwatering levels as the company delivers record profits seemingly as easily as it delivers the meat lovers' special.

How can the pizza king cope with this?
On a per-block basis, cheese prices have risen from $1.77 per pound in Q2 2013 to $2.20 per pound in Q2 2014. The farm industry is still suffering from a 2012 drought that left cattle feed in short supply.

The domino effect has been higher price of feed, which has led to farmers cutting back on cattle rearing. This has resulted in a shortage of cows, which means a shortage in cow's milk and of course a shortage of cheese.

Supply and demand came into play, and now we're all facing higher cheese prices. Luckily for Domino's, there is more to a pizza than just cheese.

While many other commodity prices, such as pork and beef, have risen too, certain other items actually got cheaper. However, the overall basket of commodities for Domino's rose 5.8% in the second fiscal quarter according to the company's most recent conference call.

Dpz

Source: Domino's Pizza.

The delicious results, costs be damned
In Domino's Pizza's second-quarter fiscal earnings results, reported on July 22, the company reported total revenue that popped 8.8% year over year. Same-store sales rose 7.7% domestically and 11.7% internationally.

Earnings per diluted share tacked on 17.5%. Both gross and net profit margins remained roughly the same percentage.

The numbers certainly don't suggest any obvious major problems with commodity costs holding Domino's Pizza back. Domino's Pizza expects between 4% and 6% commodity price inflation in total for this year.

CFO Michael Lawton stated, "We believe that this increase is manageable in the overall context of our business."

How Domino's Pizza manages the seemingly unmanageable
Domino's Pizza sells many of the required ingredients directly to the franchisees. The franchisees are the ones who ended up eating all of the higher costs, not the parent company.

Franchisees pay a royalty fee to Domino's Pizza based on a percentage of sales regardless of their profits. According to the company's annual report, this royalty fee is generally 5.5% of retail sales no matter what the input cost.

If a franchisee raises his menu prices in response to higher bills, Domino's Pizza still gets its 5.5% except that 5.5% is of that higher menu price while it shares none of the cost.  With price increases, franchisees maintain their profit margins and everybody wins including the parent company.

Since over 97% of its 11,000 restaurants are franchise-owned, it's a good to be the pizza king. 

For the other less than 3% of restaurants that are company-owned, Domino's Pizza aims to pass the higher commodity costs onto consumers in the form of higher retail prices.

In most cases, however, it actually doesn't even have to. CEO Patrick Doyle explained during the conference call, "With food costs where they were in the first half [of the year you saw] that volume growth has offset increases in food costs."  Digital ordering has largely been credited with for the volume growth. 

Photo

Source: Domino's Pizza

Higher demand and higher economies of scale largely neutralized the higher costs. There is much more that goes into a pizza, such as labor and energy, and with higher volume those costs get sliced thinner on a per-pizza basis.

Foolish takeaway
Nobody likes higher prices, and Domino's Pizza isn't crazy about them either. Doyle stated that the company would be happier if cheese costs and pork costs were cheaper as it would allow for menu prices to be lower as well.  He was implying this would stimulate even more demand among price-sensitive customers.  

However, Doyle doesn't see it as a long term issue and neither should investors. In short, cheese and meat prices may continue to escalate, but that should carry little to no weight for any Foolish analysis of Domino's Pizza stock, as it has little to no negative effect in the long term or even the short term.

Leaked: Apple's next smart device (warning, it may shock you)
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early-in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

Nickey Friedman has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers