Domino's (NYSE:DPZ) second-quarter earnings report was as glum as feared. Although net sales and same-store sales both rose, and earnings jumped 23% year over year, the rate of growth in comps slowed once again, foreshadowing a potential decline and calling into question the wisdom of the pizzeria's "fortressing" strategy.
Undermining its own success
Adjusted global retail sales rose a sturdy 8.4% to $811.6 million on a 3% gain in U.S. comps and a 2.4% increase internationally. Although that marks the 102nd consecutive quarter of higher international same-store sales and the 33rd quarter in a row of positive U.S. comps, it is also the fifth straight time the domestic growth rate was lower than the prior year and is at the low end of the chain's long-term growth forecast range. The company also missed Wall Street's expectations of $832 million in sales.
The pizza joint admits the sales pressure is a result of its fortressing program, or its opening as many new stores as possible, even if they impinge on existing store locations, in a bid to drive more sales by getting closer to its customers. It believes speedier service will enhance customer satisfaction.
Although Domino's has over 16,100 stores worldwide, just 5,900 are located in the U.S. However, the fortressing plan is in a far more advanced stage domestically than internationally, but it is ramping up the program overseas now, so it will likely dampen foreign comps growth even more.
Soon to be a global issue
Domino's opened 216 stores in the second quarter, 171 of which were located in international markets. Because foreign stores are all franchised, the pizzeria may begin seeing significant pushback from franchisees as their businesses are hurt. Domino's, though, has indicated it's not concerned if an individual store is hurt as long as it helps the company overall, which may eventually make for some salty relations.
Revenues increased by $32 million in the quarter, mostly because of opening so many new restaurants, though the rising comps helped, too. However, that was offset by unfavorable currency exchange rates, which would have made the global sales growth rate just 4.1%.
It was also hurt by Domino's selling 59 company-owned stores to franchisees, which CFO Jeff Lawrence said "will help us accelerate fortressing the New York market and further allows us to remain focused on fortressing our remaining corporate store markets."
The program rollout comes as the pizza wars intensify. Yum! Brands' (NYSE:YUM) Pizza Hut chain is courting consumers with $5 promotions, and it has over 18,000 stores worldwide. Similarly, Papa John's (NASDAQ:PZZA) is aggressively trying to overcome recent turmoil and is looking to regrow its base.
Delivering the goods is expensive
Domino's has the added problem that pizza is no longer the premier delivery food. Consumers can now get just about any type of food from just about any restaurant, meaning it's no longer the most convenient option for diners ordering out. That is likely part of the thinking behind the fortressing strategy, that being everywhere its customers are, and having its restaurants seen multiple times throughout the day, makes it likelier that the pizzeria will be the choice for delivery.
Labor costs are also pressuring Domino's, which indicates workforce expenses are going up -- whether it's a company-owned store or franchised, on the East Coast or West, because of government mandates or natural market forces.
Part of Domino's response is to test driverless delivery options by teaming up with autonomous delivery specialist Nuro, the same company that supermarket giant Kroger partnered with for grocery delivery.
A clear path needed
Support seems to be weakening for Domino's, and its stock tumbled almost 9% after it issued earnings. Despite remaining the top pizza joint in the U.S. and globally based on sales, its fortressing strategy throws a big wild card into investor opinion about how it can progress when it undermines its franchisees. Domino's needs to clearly articulate where it thinks the bottom is for franchisees with slowing comps, and what it can do to reverse the trend, before it can instill confidence that the path it's taking is the right one.