Douglas Jack and Ivor Jones at Peel Hunt give their view on the traditional pizza delivery market, which continues to be dominated by Domino’s. They question what the rapid growth of disruptors such as Deliveroo and UberEats means for the overall landscape.

“Demand growth for traditional pizza delivery has ranged between 8-10% pa over the last decade. The vast majority of this growth was driven by Domino’s Pizza. In H1 2017, against very tough comps, the market grew by just 4%; with Domino’s up 7% and the rest of the market up c1%, but our estimates, with Domino’s main traditional competitors barely expanding.

Many commentators claim this is due to new competition from Just Eat (an Aggregator) as well as Deliveroo and Uber Eats (both Aggregator Deliverers), although it also reflected tough comps and unfavourable weather.

In Q3 2017, demand growth in the traditional pizza market must have grown by more than 4% in our view, as Domino’s total sales grew by 12%, and it accounts for at least 46% of the market.

These aggregator deliverers do not yet appear to have proven long term models:

•Uber’s London private hire licence has not been renewed as it is “not fit and proper” to operate in London, according to Transport for London. So far, this has had no impact on Uber’s food delivery business.

•“Uber’s conduct demonstrated a lack of corporate responsibility, which could have potential public safety and security implications”.

• Deliveroo made a loss of £129.1m from sales of £128.6m, with a gross margin of 0.7%, in the year to December 2016. Deliveroo charges full restaurant prices plus delivery charges to the customer and often charges the restaurants the equivalent of 36% of net sales.

•According to FT Alphaville: “ for these things to be economic at micro margins they have to be cost-effective for the masses at the break-even level, if not they have to be turned into high margin luxury businesses that cater to only a fraction of the consumer base”.

•The average order cost per person is very different for Deliveroo compared to Just Eat (which does not deliver), and Domino’s.

In terms of competition, we have not viewed Just Eat as being a major issue for Domino’s Pizza, as Just Eat does not deliver, and both companies grew LFL sales strongly at the same time from 2014 to mid-2016. However, Deliveroo and UberEats have created delivery competition, even if it is unprofitable for themselves, relatively unprofitable for the restaurants (with brand/customer satisfaction risk) and potentially expensive for the customers.

We would also argue that Domino’s model is more secure because it controls its brand and customer journey from order to delivery, and tightly controls and monitors this process to ensure it maintains high levels of customer satisfaction and protects its brand’s integrity.

With all the quoted restaurant chains issuing profit warnings, and some others having gone into administration, the option of merely sending food to the customer’s homes does not appear to be a panacea for the restaurants, who’s economics do not appear to be as strong as Domino’s.

We believe franchisees’ profitability per store is significantly higher than that of their competitors, who: do not have an average of over 10 stores each; are not generating average returns in excess of 50%. Further, Domino’s sales are c5x greater than those of its nearest two traditional pizza delivery competitors, resulting in it having c5x the advertising fund.

•In 2016, Papa John’s total reported sales were 16% of Domino’s, and we estimate its reported sales per store were 55% below Domino’s.

We believe that Deliveroo/Uber Eats, at full restaurant prices plus delivery charge, cannot match Domino’s current offer set at £5/head. We doubt the other traditional pizza delivery operators have the scale, brand and advertising power to sustain a campaign like this for very long.

For Domino’s, we expect comps, weather, innovation, product offering and advertising to start to shift LFL sales up, particularly in Q4 2017. Strong LFL sales leave the bear theories in tatters; so regardless of the company’s sector-leading returns and strong cash flow, the principal catalyst for Domino’s share price should be its LFL sales