Domino's (NYSE: DPZ) has a highly impressive 25-year history of same-store sales growth. For 101 consecutive quarters, the pizza joint has posted higher sales at existing locations, a record that few businesses, let alone restaurants, can match.
But sales growth is slowing, and though the first-quarter gain of 3.9% still has it comfortably in positive territory, it also marked the fourth straight time the pizzeria posted numbers that were lower than a year ago. As it readies to report its second-quarter earnings on Tuesday, July 16, let's look at what investors might expect.
Caught in a bind
Domino's is pushing a strategy it calls "fortressing" to open as many new stores as possible in a bid to drive sales by getting closer to its customers. It has over 16,000 stores globally, almost 5,900 of which are in the U.S.
It opened 200 net new stores worldwide in the first quarter, and almost 1,150 over the past 12 months. Domino's doesn't provide quarterly or annual forecasts, but looks out over three to five-year periods. In January, it said it expects to grow stores at a 6% to 8% rate, which would equate to opening between 950 and 1,275 net new restaurants this year, or some 200 to 300 restaurants every quarter.
Most of the new openings have been in international markets -- 173 in the first quarter, compared with just 27 in the U.S. -- but Domino's is experiencing a sales slowdown in foreign markets, too.
Although Domino's refused to identify which countries were suffering the most, CEO Richard Allison noted there were several large European and Pacific region markets where it had the most work ahead of it to "better align our value proposition with local consumers."
Despite retail sales growing 9.1% internationally in the first quarter, comps slowed to just 1.8%, a big drop from the 5% increase it recorded in the year-ago period. And that included a 0.5% bump from New Year's Eve being included in the fiscal quarter.
To help its franchisees deal with the slowdown, Domino's said it will begin sharing more consumer data and insights with them, a strategy it says has helped its U.S. business, particularly with locating new stores in support of its fortressing initiative. The program is far more advanced in the U.S. than it is overseas, so Allison believes it will considerably improve the situation in foreign markets.
The high cost of business
Rising labor costs, however, continue to drain away profitability at stores, both company-owned and franchised. Despite the average U.S. franchisee generating almost $1 million in earnings before interest, taxes, depreciation, and amortization (EBITDA) -- almost triple what it was when Domino's began its fortressing program seven years ago -- labor costs are pressuring profits at the store level.
It's a dual-edged problem because not only are a number of states and cities raising their minimum wages, but a tight labor market due to historically low unemployment rates is also making it difficult to find workers, which makes it hard to add more drivers on the payroll. Domino's finds hiring more drivers actually increases sales, likely because customers get their orders in a more timely fashion, making them more satisfied with the pizzeria.
Although competitors are using third-party delivery drivers in markets with high labor costs to cut down on that expense, Allison maintains that hiring its own drivers is still the lowest-cost delivery channel, probably because of Domino's scale.
Fortunately, commodity costs haven't also risen, but labor remains a stubborn problem that will continue to be a headwind for Domino's franchisees.
Even if its business is being buffeted by those strong winds, Domino's is still coming out on top. The fortressing strategy could hurt individual stores as it cannibalizes some sales, but overall it benefits the financial health of the company, which ultimately trickles down to the franchises.
Investors should keep an eye on whether comps turn negative this quarter -- international markets seem most at risk -- and whether the tight labor market continues to eat away at margins.
Domino's is still one of the strongest chains on the market, and it has the financial wherewithal to withstand the challenges, but the path to better quarterly results could become bumpier.
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