Domino’s Pizza Group (Excerpt From Our Recent Letter)
We (Matt and Dan) will be in Omaha next weekend to attend the Berkshire Hathaway annual meeting. If anyone would like to meet up with us please contact us.
The following is an excerpt from Eagle Point Capital’s Spring 2023 letter to clients. Every six months, EPC writes to clients to explain what they own and why they own it. The portfolio-specific portion of each letter is for clients and prospective clients only. Please contact us to learn more about investing with EPC.
Domino’s Pizza Group (DPG) is Domino’s master franchisor in the United Kingdom and Ireland. It has the exclusive right to issue franchises and collect royalties there. DPG is simple, has strong scale advantages, and can be thought of as a royalty on pizza consumption. People eat pizza no matter what the economy is doing.
DPG earns high-margin royalties (a portion of which are remitted to Domino’s U.S.) on its franchisees revenue and sells dough and other ingredients to its franchisees. Vertical integration creates a cost advantage over other pizza companies that produces compelling unit economics and returns on capital.
DPG is the dominant player in the oligopolistic U.K. pizza market with nearly 50% market share. The company’s scale allows it to invest more into technology than its competitors, which widens its competitive advantage..
A few years ago DPG refreshed its board and brought in a new management team. The new leadership renewed the company’s focus on its core markets and major franchisee partners. They divested less profitable foreign operations and implemented a capital allocation framework focused on returning profits to shareholders.
DPG recently announced that they will sell their stake in their German JV to their partner (Domino's Pizza Enterprises) for £80 - £90 million, which amounts to almost 8% of DPG’s current market value. Management intends to use the proceeds for repurchases, which we welcome.
Same-store sales growth, new unit growth, and capital allocation drive DPG’s forward returns. All three engines are working in the company’s favor. Same-store sales and units should each grow 3-5% per year and substantially all of the businesses free cash flow is returned to shareholders through dividends and share repurchases. Mid-to-high single digit revenue growth combined with the current 8-10% earnings yield should produce mid-teens annual per share returns for investors before any change in the valuation multiple.
We purchased shares of DPG in the fall during a brief period of financial panic in the UK. A crash in Gilts sowed fears of contagion that spilled into the stock market and dragged shares of DPG down to attractive levels. The stock currently trades for 10-12x our estimate of earnings, compared to more than 20x for similar quality businesses (and for Domino’s Pizza Group historically).
As in all of our positions, our investment thesis does not rely on DPG’s valuation multiple re-rating higher. In fact, we would prefer that DPG remain undervalued given the attractive growth prospects and capital return program. A lower valuation creates a higher yield, and therefore higher forward returns.
To learn more about DPG, check out our post on DPG from October 2022 and our post on Domino’s from July 2021.
Do you have a “stranded” 401k from a past job that is neglected and unmanaged? These accounts are often an excellent fit for Eagle Point Capital’s long-term investment approach. Please contact us to learn more about opening a separately managed account with EPC.
Disclosure: The author, Eagle Point Capital, or their affiliates may own the securities discussed. This blog is for informational purposes only. Nothing should be construed as investment advice. Please read our Terms and Conditions for further details.