M&C Report takes a closer look at the H1 results for Domino’s Pizza Group for the 26 weeks to 29 June, talks to new chief executive David Wild and reports from a presentation to analysts.
New UK openings
Asked about the preferred locations for new UK openings, Wild said: “We’d like to open more in London. We think London is still an opportunity area for us. We haven’t been as aggressive in London as we’d like to be, given the spending power in the capital.”
He added: “Because we’ve had a very good run of like-for-likes, we can now profitably move into smaller territories because the propensity to buy pizzas is going up all the time.
“That’s allowing us to open in some towns that maybe we wouldn’t have thought about three or four years ago. Now the brand is so well established and the online ordering is so popular with customers, we can actually bring Domino’s to smaller towns and splits become more profitable for franchisees.”
Eleven new stores opened in H1, with one closure. The group anticipates 40 to 50 openings for the full year, with openings “strongly second-half weighted”.
New stores have opened with average weekly sales of £14,514, a rise of 12.4% on the comparative figure for last year.
At the period end, the firm had 868 stores in the UK, Ireland, Germany and Switzerland. Its medium term target is to grow to 1,200 stores.
Franchisee profitability
Average EBITDA for UK franchisees grew by 16.9% to £59,670 in the half year. “They’ve actually grown faster than our profits. That’s because we’ve driven sales hard. We’ve also controlled food costs, and in some places we’ve brought food costs down,” said Wild.
“What we’ve seen is that our new operating system is enabling franchisees to take labour costs out of the stores to manage their cost structures more efficiently.”
Franchisee EBITDA as a percentage of sales grew from 12.5% to 13.1% year-on-year (average weekly sales per store grew 11.3% to £17,468 per week).
Wild said: “One of the biggest changes I’m trying to bring about is a real focus on franchise profitability, recognising that we will win as the master franchisee when franchisees win - the more money they make, the more inclined they are to invest in local store marketing, invest in new stores, and that helps us to grow our business. It’s really a partnership approach with the franchisees that I’m trying to bring about.”
Food inflation to ease
The cost of food charged to franchisees grew 3.4% in H1, spurred by record high cheese prices at the end of 2013 that carried over into the reporting period.
“What we’re seeing now is that prices are coming down and we actually expect deflation in the second half of the year,” Wild said. “We expect that by the end of the year, the 12-month inflation will be about one to one and a half percent.”
He added: “We’ve brought down our prices for franchisees over the course of the last few weeks.”
World Cup
Wild said the company attributes c1% if the 11.3% UK like-for-like sales growth to the World Cup. “And the general environment in terms of the loosening of discretionary spending, that’s also helped us.”
Promotions and orders
Wild highlighted the success of “bundling” promotions over the period. In particular, the Winter Survival Deal, which ran in January and February and offers a large pizza, garlic pizza bread, wedges and twisted dough balls for £14.99, accounted for between one quarter and one third of sales in some stores.
Other promotions offered included the Summer Scorcher (£19.99 including a drink) and Footy Fan Feast (£24.99, including two large pizzas). They were available for around six to eight weeks “alongside other week-long tactical initiatives and franchisee-driven local campaigns”.
Domino’s said that bundle deals have encouraged customers to add sides and desserts to their baskets, driving add-on volumes by a third. Overall there was strong like-for-like growth in both orders (8.4%) and basket size, with items per order up 6%. Price per item was up just 0.9%.
Overall the business sold 3.7m more pizzas in the period and more than 6m more sides.
Digital ordering
E-commerce now accounts for 69.7% of delivered sales (H1 2013: 63.3%), with 38.3% of online sales coming from mobile devices (H1 2013: 27.5%). In some regions mobile now accounts for half of all online transactions. Domino’s anticipates that mobile will become its most popular ordering channel in 2015.
Wild told M&C Report: “It’s growing very rapidly and one of the lessons we’ve learnt is that the easier you make it for customers to order, the more they’ll order. Online really lends itself to the type of deals that we’ve spoken about because you can communicate so eloquently with great pictures, great photography online, whereas if you’re relying on print media the lead time’s longer, it’s less flexible.
“It meets the needs of customers and also gives us the opportunity to be very agile in the types of offers we put before our customers.”
Wild added that the growth of online ordering is ”very good news for franchisees” because it requires fewer employees to process orders, and leads to greater accuracy when orders are taken. “It’s another way of driving franchisee profitability.”
Digital: new website
Domino’s said a new website for the UK and the Republic of Ireland includes an improved customer experience, with personalised landing pages that can save previous orders and personalised offers. The new site also offers increased perceptions of value, the company said, with deals automatically applied to baskets. The new site is to go live in September.
Digital: app and social media
In addition, there were 2.3m new app users during H1, taking the total to over 5.5m. There were 11.1% more customer visits to the website, generating nearly 370m page views.
Domino’s has over 946,000 Facebook fans and the group highlighted the how it is using quirky and funny social media campaigns to generate interest. For example, an April fool about an edible pizza box reached 3.5m people on social media.
Domino’s said it is continuing to divert more marketing funds to digital, spending 48% of its media budget during the half, up from 39% in H1 2013, on digital based marketing. “We are exploiting the trend of second and third screen viewing by consumers who are watching TV whilst interacting with one or two other devices, and won an award for our sponsorship last year of the X Factor App. Customers are increasingly influenced by social media and in a recent survey 15% cited it as their prompt to order. We are exploring novel campaigns that attract attention in this space.”
TV campaign
Domino’s said its “Greatness” TV campaign, launched in September 2013, which emphasises its quality credentials, has been “well-received by consumers”. “Our regular ‘Brand Tracking’ research shows that since this has been aired, there has been an improvement in the brand affinity metrics most marked within families.”
Food innovation
Domino’s said it continues to innovate in products with new toppings regularly added to the menu. For example, the Carnivale range of pizzas were launched in May to coincide with the World Cup, plus sides of nachos and fajita wedges. “We are also enhancing staple products, for example our Chicken Wings, where we have changed the marinade to give better coverage.”
UK competitors
Asked about the level of competition among Domino’s rivals, Wild said: “I’ve always been someone who’s been inspired by competition. Papa John’s is a very good business - we’re better, but we have to stay better.” He also said Domino’s looks at the Just Eat website “all the time” to “make sure that it’s easier to order Domino’s pizza than it is to order a Just Eat pizza from an independent online”.
Germany
“I would describe Germany as work in progress,” said Wild. “The fundamentals are that it’s 81m of the richest people on the planet, the Domino’s brand is successful in over 70 markets worldwide, so there’s no good reason why Domino’s will not be successful in Germany.”
The company said it had a “difficult” six months in Germany, where like-for-likes fell 1.7%, as it changed its operating framework and focused on developing an economic model that’s attractive to franchisees. Corporate store losses in Germany were higher than expected because the transfer of stores to franchise has been slower than anticipated. Germany’s operating loss for the period was £4.7m. Low sales growth also contributed to the losses.
The company has reorganised the German head office, reduced local marketing spend and lowered food costs. Wild said: “We’ve deliberately not spent as much money on local marketing because we weren’t content that we had the right offer in terms of labour and pizza quality, and we didn’t want to make a difficult situation worse.”
It also focussed on our financial reporting “to ensure we have better oversight of business performance”.
Four stores have been allowed to ‘mothball’ in the period. “We’re not giving the keys back to the landlord or taking the ovens out,” said Wild. “Those stores were performing so badly they were beginning to be a distraction to the management. What we wanted to do was focus our efforts on stores where we’ve got a prospect of making positive cashflow and then we’d hope to re-open those mothballed stores next year.”
Wild said he would like to see like-for-like sales in Germany recover towards the end of the year “as management can focus more on promoting the business”.
Four stores were opened in the country in the period. “We will almost certainly be conservative in our openings next year because I think it’s too early to plan a big opening programme, but we would like to open some stores.”
Ireland
System sales in Ireland grew from €24.6m to €25.4m, with no new stores opened either this year or last.
The company said: “After the economic crisis, we have now seen six consecutive quarters of sales growth and are encouraged by the progress made in the region. Sales growth has been stronger in Dublin, but we are also seeing positive trends in other areas. Longer opening hours have been of particular benefit in ROI and late-night has been a major contributor to the positive sales trend.”
The use of e-commerce is lower than the UK but Domino’s is seeing a rise in mobile ordering, which, at 40.3% of digital sales, is higher than the equivalent number in the UK. “We see this as an area of future opportunity.”
In Ireland, Domino’s is trialing ‘Pan Pizza’, a deeper crust product that has been “very successful” in the US. “It is early days, but franchisee feedback and customer response is encouraging.”
The firm added: “We have not opened any new stores in the ROI since 2011, but we are now looking carefully at whether there are store split opportunities in Dublin, where we have some very high sales units.”
Switzerland
Like-for-like sales in Switzerland grew 2.9% in the period, including the impact of a store closure for refit. Currency changes meant that overall system sales were flat.
Operating loss in the period was £0.4m, due to slow sales at the start of the year and a delay in the store opening schedule. The company said positive like-for-like growth in Q2 “gives us confidence that we will break even” in that quarter and reach profitability in Switzerland in 2015.
“We are encouraged by the continued strengthening sales performance as the year progresses,” the company said. “We anticipate stronger growth in the second half of the year as we open four more stores and relocate three existing stores in good locations across the country.”
Wild said Switzerland had been a “sleepy market for a number of years”.
A senior UK operator who previous worked for a Domino’s franchisee has been seconded to support the Swiss business in the second half.
Domino’s said: “Having completed the integration of Switzerland into our Group in 2013, the focus now is to improve the store estate, which is both dated and under-developed. In the first half of 2014, one store underwent a major refurbishment that necessitated a four week closure. A second was relocated within the catchment to a superior position with much greater carry-out potential. These projects have performed well and demonstrate the potential of the market.”
Exceptional items
Results for the period include a net exceptional credit of £0.8m (2013: charge of £9.9m). There was an exceptional operating charge of £0.5m; operating exceptional items include a £0.8m charge relating to the impairment of store assets in Germany and the UK, a £0.1m credit in relation to onerous lease provisions in Germany and the UK and a £0.2m credit in relation to the onerous contract in Germany. There was also a non-operating exceptional credit of £1.3m. This includes a £0.2m credit relating to the sale of store assets and a £1.1m credit in relation to the release of contingent consideration in respect of Domino’s Pizza Switzerland.
In addition, there was an exceptional interest charge of £0.4m relating to the unwind of discounts on Domino’s Leasing deferred consideration and the onerous contract provision in Germany. An exceptional tax credit of £0.4m represents the net tax effect of the exceptional items.
New role
Wild, who started his job in April, said he’s “having a great time” in the position. “I’ve worked in multi-site consumer for many years but I’d never worked in franchising and I’d never worked in QSR. I’m actually very privileged because I had a chance to try the job before I took it. I joined the Dominos board as a non-executive director and I stepped in as interim CEO and enjoyed it so much that I took the job on permanently. It’s quite unusual to ‘try before you buy’ at this level!”
Analysts
Douglas Jack at Numis issued a Buy recommendation for Domino’s and upgraded his forecast slightly for the group.
“We are upgrading our 2014E PBT forecast to £52.7m from £52.2m (consensus £53.8m) on cautious FY assumptions of 5% LFL sales growth and falling EBIT margins. The 2015E P/E is 17x if one excludes Europe, a potentially valuable option, which we view as low for a company with 24% underlying growth and almost zero debt and net rent.
“H1 reported PBT rose 10% to £24.5m (we forecast £24.5m / consensus: £24.6m). This included £3.0m of one-off costs, without which underlying PBT was up 24%. With UK LFL sales up 11.3%, UK/Ireland margins up 51bps and European losses stabilising, we are upgrading our forecasts by 1%. We believe further upgrades are likely.
“In H1, UK LFL sales rose 11.3% (vs 6.4% comp). In Q2, LFL sales rose 11.8% (Q1: 10.8%), of which 2.2% related to the World Cup. LFL trading is benefiting from increasing consumer confidence, improving product range and bundle deals driving up add-on volumes by a third. Momentum should continue in Q3, aided by slightly easier comps (of 4%) and the roll out of the new customer website over the summer.
“UK/Ireland margins rose 51bps in H1 (+87bps excluding one-off board-related costs), even though supply chain gross margins were flat, as guided. Despite average food cost inflation of 3.4%, average franchisee profitability rose 16.9% in H1. Food cost inflation has abated, such that it should be 1.0-1.5% over the full year (H2: negative). We estimate this should boost franchise profits by a further 2-3% in H2.
“In H1, eight sites opened in the UK and three sites opened in Germany, with guidance reiterated for 40-50 UK openings, five German openings and four Swiss openings over the full year. Average sales from new UK outlets are up 12.4% compared to H1 2013 and up 28.0% compared to H1 2012.
“In Germany, reported losses were £4.7m, although underlying losses (excluding one-off items) fell to £2.4m from £3.2m with reduced overheads offsetting a 1.7% fall in LFL sales (partly due to lower marketing spend). Four German stores closed and there are still 10 sites to be converted to franchise. In Switzerland, losses were flat at £0.3m; LFL sales growth (+2.9% in H1) and expansion are expected to move Switzerland into profit in 2015E.”
In a note entitled German pizza party pooper, Nick Batram at Peel Hunt issued a Hold recommendation and said: “Domino’s Pizza knows about consistent delivery and interim results were more of the same; an excellent UK offset by another poor performance in Germany. The strength of the core business is reassuring but Germany will remain a distraction, with no sign of an exit or recovery.”
Sahill Shan of N+1 Singer said: “Whilst we are encouraged by another strong UK showing our preliminary reaction around the International results is one of disappointment. Whilst we acknowledge there is some underlying stability in terms of losses, it is clear that there is still plenty of work to do to drive shareholder value.
“Admittedly the current share price is well underpinned by the DCF valuation for the UK business at >550p, but we stay at Hold given International is still a mixed picture.”
