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Domino's Didn’t Deliver the Goods in Q3, But Mr. Market Isn't Complaining

By Motley Fool Staff - Oct 13, 2019 at 6:00PM

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Despite its earnings and revenue misses, share prices rose Tuesday.

Leading pizza chain Domino's (DPZ 1.20%) has been on a decade-long growth tear -- and if you bought shares back in autumn 2009, you can afford all the extra pepperoni your want, because the stock has been more than a 25-bagger since then. But when it reported third-quarter earnings Tuesday morning, growth wasn't the big story. The company missed on revenue and profits. Yet share prices rose. And if you were going to guess that what pushed them higher was guidance, guess again -- management dialed it back. So what's happening here?

In this segment of the MarketFoolery podcast, host Chris Hill and senior analyst Ron Gross talk about everything Domino's has been doing right, the competitive disruption in its market that's beyond its control, and why its new CEO may have taken over at a less than opportune time.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Oct. 8, 2019.

Chris Hill: We're going to start with Domino's Pizza. Third-quarter profits in revenue came in lower than expected. They cut their revenue guidance. Why is this stock up 4%? This is a company that has performed so well for so long, this was not a great quarter, and anytime you're cutting revenue guidance, that doesn't go in the plus column.

Ron Gross: It's interesting you say that. The last time I looked at the stock, it was actually down. It must have rebounded for reasons unbeknownst to me. [laughs] This is a personal one for me. I know we're not supposed to get emotional about our stocks, but I've been with this company, both professionally and personally --

Hill: Oh, yeah!

Gross: [laughs] -- for a really long time, like a decade. What a wonderful story. They really did everything you would want a company to do. Everything from being honest about the menu, revamping the choices, to embracing the digital world, great leadership over the years. And the stock reacted. Really great performance.

But now, lately, we're seeing -- through no fault of their own -- competition come in to play. It's the folks like Uber Eats and DoorDash and Postmates and Grubhub, those guys. What do you do when you're doing everything right, and through no fault of your own, something comes in to shock the system, and either disintermediates or disrupts what you've been doing pretty darn well?

So, even though you're not supposed to get emotional about your stocks, I feel bad that this is impacting Domino's business. And it is, and it will continue to do so. Pizza, and perhaps Chinese food, is not the only game in town now when you want to get food delivered. That really will impact the business. I feel like it's almost a new normal. The company will continue to do well. They will continue to innovate. They will continue to make pizza that I don't think is amazing, but that people like. It's just not going to be the robust growth that they had over the last, let's call it three to six years, because competition has come in.

Hill: I think the growth goes back even before that. The person leading all that was Patrick Doyle. Did a phenomenal job over the past decade. As you said, starting with the whole campaign where they came out and basically said, "Yeah, our pizza is not that good. We're going to work to make it better." The digital revolution, embracing all of that. Patrick Doyle is no longer running the company. Rich Allison took over in July. Look, it's early days for him as a CEO, but it's not off to a great start. This is probably a little unfair, but --

Gross: It's still no fun.

Hill: It's the combination of, it's a really tough act to follow, because Doyle did an amazing job leading this company. Maybe that's part of Doyle's brilliance, is deciding to leave at the right time. But the next couple of quarters, if they look like this, where it's, "Yes, we're growing same-store sales quarter over quarter, year over year, but not to the degree that we did in the past. We're doing good, not great," then Rich Allison's first year is probably going to be frowned upon.

Gross: Yeah. Looking into my crystal ball, I think that is what we're going to see. In fact, the company is telling us that with their guidance. They replaced their three to five-year forecast with a shorter-term outlook, saying, "It's harder for us to actually look out that far, so we're only going to look out the next two to three years." But they've reigned in their growth. They're looking at 2% to 5% same-store sales in the next two to three years, rather than 3% to 6% over the longer term. They're signaling to us that the writing is on the wall. Competition is real. That will impact numbers.

Is 2.4% U.S. same-store sales, which they just did this quarter, is that a bad number? No, that's not a bad number. It's just not as good as it was, and it looks like the days of the 4% to 6% same-store sales numbers could be behind them, unless they pull a rabbit out of a hat and come up with something that's pretty exciting. What those things usually are promotional. For example, they offered half off online orders for a week in August. They launched a 20% offer for late night orders in September. You can do that. But what that ends up doing is impacting your margins, because you're making less per pizza, per unit of food. That impacts your margins, that impacts your profitability. You might get a boost in revenue, but it'll be less profitable revenue per dollar.

Hill: It's interesting that a lot of the talk -- I think you're right in this regard -- is about the expanded competition in the world of, anything can be delivered. DoorDash, Uber Eats, etc. That being said, Rich Allison also has the misfortune of taking the top job at Domino's at a time when year two of Pizza Hut's sponsorship with the NFL kicks in; Papa John's may be turning the corner?

Gross: "Maybe" is a good word.

Hill: I think over the next six months, it'll be interesting to watch those two as competitors. And, this whole issue of third-party delivery. Domino's continues to toe the line and say, "Look, we don't think the economics work. That's why we're not doing it." It'll be interesting to see, six to 12 months from now, if they're holding the line on that, and in fact it works out for them; or if they decide to maybe strike a deal with someone, and then they can't fight the tide.

Gross: Remains to be seen. I have a feeling the answer's no. We'll see. Companies like McDonald's, I think McDonald's might be the No. 1 Uber Eats brand. I guess that's not surprising. It's cheap. I guess it tastes good, if you like that kind of thing. People just want their burgers and fries. But again, there's so many offerings now. You want BBQ? You get BBQ. You want Indian food? You get Indian food. You can have anything you want. It has really changed the game. It would be completely surprising if that didn't take a bite out of market share or revenue from companies like the traditional pizza companies. We'll have to see what the new normal is, and what stock price makes sense for the new normal. This stock on the face of it is not necessarily expensive here, even with the reduced guidance. It's returned 23 times forward earnings. Look at Papa John's, which is 42. Papa's struggling, obviously. Starboard Value is coming in --

Hill: It's 42?

Gross: Yeah, forward earnings. The earnings are depressed, that's why. We'll see if Starboard can right the ship there. They have a great track record. I wouldn't sleep on them, they're going to get stuff done. But the 23 of Domino's is more in line with a McDonald's at 25. On the other side of the coin, you have Chipotle, over 50. That's pretty expensive here. Not such an expensive stock, but it's hard to get excited about a company that is signaling to you that weakness is coming.

Chris Hill has no position in any of the stocks mentioned. Ron Gross has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Chipotle Mexican Grill. The Motley Fool recommends Uber Technologies. The Motley Fool has a disclosure policy.

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