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Domino’s earnings could indicate core customer base ‘disproportionately feeling pressure’: Analyst

Morningstar Equity Analyst Sean Dunlop joins Yahoo Finance Live to assess Domino's Pizza's worst trading day since May 2010, the outlook on the food delivery space, and where fast-food customers may be finding alternative options and pricing pressures.

Video Transcript

BRAD SMITH: All right, well, it's been a busy day for food stocks. We were just talking about one of them, but we've got to refocus our attention on Domino's having its worst day in more than a decade, folks, after the company missed Wall Street same store sales estimates. Here to break down the outlook for food stocks, we've got Morningstar equity analyst Sean Dunlop. Sean, great to have you here. What happened with Domino's?

SEAN DUNLOP: Yeah, no beating around the bush. A 12% decline in share prices-- obviously, the market didn't like earnings. I would say if I had two issues that I would identify as sort of being the principal drivers in that report, it would be, one, they lowered their system sales guidance by about two points, to 4% to 8% over the next three years from 6% to 10% prior, and their new unit development targets from 5 to 7-- or to 5 to 7 from 6 to 8. And then, two, we saw a lot of pressure in the delivery business. That delivery business has grown only 3% relative to the pre-pandemic base, meaning that a lot of those gains that the company saw in 2020 and 2021 have fizzled out at this point.

INES FERRE: And Sean, talking about that delivery business, I mean, the company has really built its strategy around it. Do you think that they should be outsourcing that? Do you think that the consumer is just absolutely too squeezed with this inflation?

SEAN DUNLOP: Yeah, a couple of good questions. I mean it's absolutely within our expectations that delivery would normalize. We were never going to see an environment where 2020 and 2021 would continue ad infinitum, particularly as dining rooms opened back up. I mean, looking at this from a 30,000 foot view, if you told me that Domino's would see its delivery business grow only 1% per year over the past three years, and that the company would gain three points of market share in the United States, I'd be over the moon.

But to your point, the delivery channel is the high cost channel. You're layering on not only a $4.99 delivery fee in most markets, but also a 20% tip. And so consumers typically do trade down from that category during periods of economic pressure like we've seen. That said, we've seen a little bit of pressure for the company to adopt partnerships with third party aggregators, like we've seen at Papa John's, like we've seen at Pizza Hut. I don't know that that's necessarily the solution, given that Domino's tends to index very heavily to a value oriented, lower income consumer. And given that third party aggregator channel, you're now layering in a 15% marketplace commission as well. So it's actually the highest cost delivery fulfillment channel.

BRAD SMITH: You know, Sean, I think about some of the great pizza that we got here in New York City. We got Artichoke. We got MB Squared. We got Roberta's. But even when I do order something that is not those players here on the local scale, I ordered a Papa John's pizza, I got to tell you, and I think it comes down to what the consumer taste profile is looking like right now. Has there been such a massive shift that is a detractor for a company like Domino's right now?

SEAN DUNLOP: Yeah, I would say as you look across the restaurant landscape more broadly, the companies that have been healthy sort of year to date in the fourth quarter are companies that skew towards an affluent client. You think about Chipotle. You think about Starbucks, probably a Chick-fil-A in those brackets. And that, I would argue, is the bucket that you fall into. So as you think about the aggregator partnerships, you think about Papa John's and the success that they've had, it makes some sense. Those are typically younger. They're typically more affluent customers.

And when they're visiting a delivery aggregator platform, they're more likely to order a Papa John's. Maybe they're more likely to order a fast casual like a MOD or a Blaze. So I don't know that it's necessarily that the market is moving away from Domino's as it is that their core customer base is disproportionately feeling the pressure that we see right now.

INES FERRE: Brad is a high paying customer, but Sean, talk to us a little bit about workers and wages for workers. How much of a drag is this for companies like Domino's that have to increasingly pay higher wages?

SEAN DUNLOP: Yeah, it's been a real problem. And, you know, wages are not something that's going to go away. That's something that they mock up and that stays high. And so even as you see commodity costs start to abate and that eases some of the pressure that we've seen in terms of margin compression for restaurants, wages aren't going to do the same thing. And so an environment where operators continue to see a more pressured customer and may struggle to increase prices over the next quarters, I think it's going to be difficult with wages up in the low 20s-- I think it's 22% since February 2020-- to be able to generate margin recapture that maybe the Street had initially been contemplating.

BRAD SMITH: Sean, I know you don't cover Beyond Meat, but I'm kind of pairing together two reports here, one from Beyond Meat that, quite frankly, I don't know why the shares are moving higher in after-hours trading. I'm continuing to look at this report-- and one from Domino's that the Street didn't like here. Does this mean that we're not going to see a Beyond Meat meat lover's pizza over at Domino's?

SEAN DUNLOP: I think I would use the cop-out answer, the Ray Kroc McDonald's answer, which is when the consumer is ready for it, it will be available. What we've seen over the last couple of quarters is a lot of these plant-based pilots at most QSR restaurants. Consumers have really not embraced it and may not be ready for it yet. But when they are, I'm sure that'll be available as a topping on your Domino's pizza.

BRAD SMITH: Sean, that is just a fine answer here for this afternoon. Sean Dunlop, we appreciate the time and the analysis. Thanks so much.

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