Domino's Pizza (DPZ -1.55%) has thrived since the pandemic onset. The global quick-service pizza giant benefited when many restaurants were forced to turn away in-person diners. That created a surge in ordering food for delivery and pickup, an area Domino's excels at.
There was always a concern from investors that Domino's would be harmed when economies started reopening, but it's coming from a surprising factor. Investors thought it would be customer demand for ordering pizza that would fall off. Instead, it's rising costs causing the biggest headache for Domino's.
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Domino's costs are soaring
Indeed, in its most recent quarter ended Sept. 12, Domino's reported global retail sales increased by 10% from the same quarter the year before. That's impressive, considering that sales grew 14.4% this time last year and restaurant restrictions were a lot less common in 2021. It looks like folks are maintaining habits gained at the more restrictive phases of the pandemic rather than experiencing pizza fatigue.
The challenge for Domino's is to fulfill the surge in customer demand. CEO Richard Allison said this about the issue at an investor conference on Jan. 11:
And we expect unprecedented increases in our food basket costs versus 2021 of 8% to 10%, which is 3 to 4x what we might normally see in a year. I think many of you are aware of the significant inflation across the U.S. economy and how that is hitting many of the inputs that we have for our business, from meats, to cheese, to some of the grains that go into the production of our products. So 8% to 10% versus 2021. We also expect to continue to see wage inflation across the industry, and that will certainly impact us at Domino's as well.
Interestingly, unlike many other businesses facing rising costs, Domino's has chosen not to pass along price increases to consumers. Instead, Domino's is making adjustments to lower variable costs. For instance, Domino's will decrease the number of wings in an order from 10 pieces to eight while keeping the price the same. Further, it will create specific online-only promotions, saving the expense of paying workers to answer phones and take orders.
Essentially, the moves are undercover price increases; customers will pay the same amount but get less bang for their buck. Of course, this type of strategy is not new: Think about the last time you bought a bag of potato chips and opened it -- to find it only halfway full.
What this could mean for investors
Thankfully for shareholders, Domino's has healthy operating profit margins to sustain rising costs. Domino's operating profit margin has consistently remained between 15.7% and 18.7% in the last decade. That leaves the company wiggle room to absorb higher costs while delivering excellent profits. Still, rising inflation could be one reason why Domino's stock is already down 13.7% year to date in 2022.
Moreover, Domino's has been trading at a price-to-earnings ratio at the higher end of its range for the last 10 years. It's not surprising then that risk to profits would send the stock lower in the near term. However, it's no reason for long-term investors to panic and sell the stock.
