Domino’s Pizza Group: A global brand going cheap

Domino’s Pizza (Nasdaq: DPZ), the US arm of the global Domino’s brand, has been a fantastic investment for those shareholders who’ve stuck with the business over the past 15 years. According to figures compiled by Morningstar, the stock has generated a total return of 27.1% per annum over the past 15 years, outperforming the benchmark index, which returned just 14.4% over the same period.

Domino’s business model is simple. It runs an “asset-light” franchise model supported by a vertically integrated supply chain and advanced technology. Most of its earnings come from franchise royalty fees and income generated from selling supplies via its supply-chain network. This translates into a highly cash-generative business model.

Last year, Domino’s generated cash flow from operations of $625 million and invested just $31 million back into the business. Virtually all of the remaining cash was used to repurchase stock and fund the dividend, a strategy management has followed for some time. Over the past five years, share buybacks have almost doubled earnings per share growth.

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Troubles at Domino's Pizza Group

Sadly, the UK arm of Domino’s, listed as Domino’s Pizza Group (LSE: DOM), hasn’t been able to replicate the performance of its much larger US-listed peer. Earlier this month, the stock hit a 10-year low.

The last time the shares were changing hands for 200p, earnings were two-thirds of today’s level and the share count was 100 million higher than today, suggesting something has gone seriously wrong. The stock hit an all-time high of more than 450p in December 2021. Since then, it’s been on a roller coaster, with the current decline starting in 2023. It’s since lost 50%.

The company’s troubles can be traced back to the appointment of the current CEO, Andrew Rennie, who joined the board in August 2023. A few months after Rennie joined, it emerged that the team was looking to buy a second fast-food brand to add to Domino’s UK empire.

The company believed it would be able to leverage its size and experience to build a new brand into a force to be reckoned with, replicating Domino’s near 60% share of the UK pizza market. It’s beginning to look as if management has taken its eye off the ball in the hunt for a second acquisition.

At the beginning of August, the group issued a major profit warning, saying that, due to a “tougher operating environment”, it was lowering its 2025 profit forecast by 12%. A decline in like-for-like sales and flat total orders added fuel to the fire.

Cyclical issues

However, Domino’s issues appear to be cyclical rather than structural. The group remains highly cash generative and, while growth has evaporated, consumers are loyal.

Its loyalty programme trial, for example, is performing ahead of expectations. Management recently outlined plans to return £20 million to shareholders via buybacks. According to Panmure Liberum, this represents about 2.6% of the share capital and could yield an equivalent rate of return of 12.6%, comparable to an annual profit boost of £2.6m.

Panmure Liberum calculates that if Domino’s returns more than £50 million, the rate of return jumps to more than 13%.

At this rate, it makes sense for the company to use its funds to retire shares rather than acquire other businesses. Panmure Liberum estimates that, in the most aggressive scenario, where Domino’s takes leverage up to the top end of its target (2.5 time earnings before interest, tax, depreciation and amortisation), the group can spend £219 million by 2029 buying back stock using both debt and free cash flow from operations – around a third of its current market value. Activist investor Browning West is campaigning for the company to do just that.

Domino's Pizza Group: the verdict

Browning West owns 5% of the firm, making it one of the largest shareholders. The founder and chief investment officer, Usman Nabi, recently wrote to Domino’s asking it to “pause any contemplated acquisitions for six months and immediately initiate a significant share-buyback programme of at least £100 million to be completed before year end”.

He explained this approach would make the most sense for the company, as a large deal would come with enormous risks for the business, as well as requiring a significant amount of the senior management team’s time. He argued it would be better to focus on the group’s current operations and growth.

An activist at the gates isn’t always good news, but in this case it could prove to be the shove the board needs to change direction. The recently announced £20 million buyback is a positive sign and is expected to generate robust returns on the cash.

After recent declines, the shares are also trading at one of the lowest valuations in recent history and the stock looks incredibly cheap compared with its international peers. Domino’s offers a rare combination – a strong brand going cheap.

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