Domino’s Pizza is a surprisingly well-known brand. While it might not be the best pizza you can get out there, it’s one of those brands that most people are very familiar with.

And while I’m no longer much of a Domino’s consumer, my stomach won’t allow me to, I still have a lot of experience with the brand and have some very fond memories. So when I discovered Domino’s was down nearly 50% from its all-time highs, I couldn’t help but take a closer look at the business.

And what I found was a royalty-like business, running three primary business segments: A business with a dominant share of the pizza market both in America and globally, a business with some incredible unit economics due to its franchise business model, and a business that has allocated capital intelligently for decades to create a ton of shareholder value.

If you’ve ever wondered if pizza shops can make a profit, the answer is a resounding “yes”, but only when you have the right business model and scale.

Let’s get into it!

— Kyle

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There’s a story about Domino’s that is both funny and sad. In 1960, two brothers, Jim and Tom Monaghan, bought three struggling pizza shops in Michigan for just $900. A few months in, Jim decided the whole thing just wasn’t going to go anywhere and was willing to trade away half the company for a yellow Volkswagen Beetle they’d been using to run their pizza deliveries! Jim took the car, and Tom kept the pizza. The pizza company would eventually be worth billions of dollars.

With most good stories about missed fortunes, listeners take the wrong lesson. The usual moral is to never sell. Don’t be the guy who sold a large percentage of Apple for $800 or the guy who sold half of Domino’s for a used Beetle.

The real lesson is in imagination. In 1960, that Beetle was definitely worth more than half of those three pizza stores. Jim made a rational decision based on what he knew at the time. But he had zero idea that his brother was about to spend the next four decades building a pizza empire spanning the entire globe.

Merriam-Webster defines a franchise as: the right or license granted to an individual or group to market a company's goods or services in a particular territory.

A franchise is a type of business model. The kind where one entity owns a powerful brand that it licenses in exchange for a percentage of revenue to those who can provide the capital and manage the operational work of scaling the business. In this sense, Domino’s is one of the purest expressions of a franchise in retail that I’ve ever seen.

But there is another meaning. Maybe you could call it a legacy definition, in the sense that Warren Buffett popularized it. He described an economic franchise as a company that provides a product or service that is:

When all three hold, you get a business that can price aggressively year after year and earn incredibly high returns on capital. And when you have these attributes, each new franchise is basically a permission slip to print cash.

In the first sense, Domino’s is definitely a franchise business. In the second sense, I don’t think it meets all three of Buffett’s criteria. It clears the first hurdle: people will always crave pizza. I just have to ask my three-year-old son, and there are about zero times out of ten that he would say “no” to pizza. Pizza also isn’t subject to any price regulation, which is why its price has steadily gone up over time.

But that second point is where a business like Domino’s meets friction. Just by opening up the Uber Eats app, you can have 50 different pizza brands delivered to your door in no time. Nonetheless, Domino’s has now been around for 66 years and has built an extraordinary machine to compensate for the fact that it doesn’t have the strongest of moats. The question we have to ask today is whether that machine is still strong enough.

One of the more fascinating parts of the Domino’s origin story is how Tom initially saw the pizza business as a side hustle. Something to help pay for his architecture school. But when his brother left the business, Tom faced a decision. Stick with the pizza business and give it 110%, or quit and pursue architecture. He chose the former, and I doubt he’s ever regretted it.

But what he did after siding with Pizza reads a lot like Sam Walton to me. He’d drive to all the competitors in the area and eat their pizza. He’d take notes on which was the best sauce, because, according to Tom, the best pizza sauce wins. While doing his scuttlebutt, a supplier told him about a restaurant nearby with the best sauce he'd ever tasted. Tom charmed the owner into handing over the recipe, which he then used for his own restaurant. Additionally, he redesigned the oven and counter layout to shave seconds off the time it took to build a pizza, resulting in more pizzas per hour within the same four walls.

He also cut the menu from five sizes to two for simplicity, and profits went up immediately.

None of these are durable moats. Any other pizza store owner could have put in the sweat equity Tom did to better understand his competitors. But they didn’t, and he did. This is a prime example of how small businesses win. By doing all the small, unglamorous things your competitors aren’t willing or don’t have the time to do.

Even the name Domino’s is a tell of how Tom thought. When the original owner demanded Tom change the name from DomiNick’s, Tom settled on Domino’s simply because it landed on roughly the same page in the phone book!

After meeting Ray Kroc of McDonald’s and John Brown of KFC, Tom decided to pursue the franchisor model. How else would he end up with private jets and a driver? And Domino’s provided Tom with everything he needed, allowing him to exit the business in 1998.

If you’ve ever given Domino’s a quick glance and seen their less-than-mediocre top-line growth of 6% compounded annually over the last two decades, you’d probably think, “I’ll pass, unexciting.” But then you’d miss that, over the same time frame, they compounded earnings per share by around 15% annually, meaning earnings would have doubled four times over that period.

Today, Domino’s is the largest pizza company on earth. They operate in 90 markets around the globe. Its two largest competitors are also pizza chains with slightly different business models. Pizza Hut focuses more on dine-in. And Little Caesars focuses more on cheap carryout. Domino’s has stayed true to its DNA of pizza delivery.

Part of what I like about Domino’s is the simplicity of its business model. They generate revenue in three different ways:

While the Supply Chain segment accounts for a large portion of Domino’s revenue, its margins are by far the lowest of the three segments. It is primarily a logistics segment. And it functions not only to ensure Domino’s brand stays intact but also to incentivize franchisees to sell more volume and share in the operating income from the supply chain segment’s profits. So Domino's keeps those margins near 10%.

But as we move up to the individual stores, things start improving. They run at margins nearing 40%, a big improvement. But neither of these compares to the incredible margins Domino’s earns from its franchise royalties, which run at 85%. It’s worth noting that international franchisees tend to be master franchisees, and because they handle more of the backend work in the supply chain, Domino’s Pizza takes a smaller percentage of revenue from them than from US franchisees.

Whenever I analyze a company, I like to ask why a business would bother keeping lower-margin segments. If there is no good answer, it usually means management probably isn't running it well. But in Domino’s case, I actually don’t think that’s the case. The corporate-owned stores, for instance, allow the corporation to understand the pains of owning and operating a Domino’s franchise. And this is why they’ve scaled so much while other pure-play franchisors have failed.

When you think of a pizza restaurant, your first thought about who the customer is is you! Don’t worry, you’re not being selfish. In Domino's case, though, the customer is the franchisee — the operator who actually bakes your pepperoni pizza and chocolate lava cake and drives it to your door — not the person eating it.

This is how franchises work. Yes, you have to sell a good product to the person who consumes your food, but what matters most is making sure you take care of your franchisees, ensuring they are turning a profit, and never making them feel exploited.

There are roughly 754 independent franchisees who run roughly 6,900 US stores. The fact that many franchisees hold multiple stores tells you something important. These aren’t hobbyists. Most owners had to run a store for at least a year before earning the right to franchise. So, many owners know what it’s like to bake Domino’s pizzas or deliver them. But more importantly, Domino’s Pizza is completely aligned with its franchisees. They both make money together and lose money together.

Quiznos did not create the same type of alignment that Domino’s has created. It’s a case study in how to fail not only as a franchise, but as a business. Just for some backstory: Quiznos went from 5,000 locations in 2007 to just over 300 today. But it didn’t die purely due to competitive pressures.

It died of a broken relationship between the corporation and the franchisees. The primary hangup was that Quiznos forced its franchisees to purchase ingredients from Quiznos’ supply chain subsidiary. It sounds ordinary until you find out that the supply chain was completely gouging its franchisees, forcing them to accept worse margins so that the supply chain subsidiary could fatten its own pockets.

Once franchisees realized Quiznos was squeezing them, class-action lawsuits ensued, ultimately bankrupting the business.

But I think Domino’s has handled this tension between franchisor and franchisee very well. Franchisees that choose to purchase from Domino’s own supply chain share in 50% of the operating income that these supply centers generate. This helps create healthy incentives, where franchisees feel like they are getting a good deal from buying from the supply chain and directly benefit from selling the product. I think Domino’s Pizza has helped turn a potential profit extraction point into a profit-sharing arrangement that benefits everyone.

Domino’s Pizza is a business I find both impressive and unsettling at the same time.

On the one hand, there is no patent on dough, cheese, and pepperoni. Pizza also has no switching costs. I doubt you know anyone who eats pizza exclusively from one restaurant. Compare that to a company that relies on hyper-specific software to run a million-dollar business: that’s a moat. Pizza simply doesn’t offer the same competitive advantages, and you can't really bend the rules to make it so.

But something has to explain why Domino’s has been in business since the early 1960s, selling a commoditized product. Not only have they survived that entire time, but they’ve also completely thrived, with over 22,500 stores globally. If the business is so weak when it comes to competitive advantages, what explains the dramatic growth path?

The first is their strategy in store placement. They call it fortressing. They take a complete 180 on cannibalization and deliberately pack stores close together. After all, a pizza traveling two miles arrives faster and hotter than one traveling 10 miles.

The next advantage is that Domino’s is one of the few businesses that delivers its own food. Even though they are the largest pizza option on aggregators like Uber Eats and DoorDash, they use their own delivery drivers. Since Domino’s runs its own software system to optimize for delays and delivery times, using their own drivers makes the most sense. It allows them to create the best possible customer experience. Yes, they sacrifice some margin here, but they make up for it by avoiding the horror stories that food delivery apps can provide.

Another advantage requires you to think for a second like a potential restaurant franchisee. If you have the option of opening a pizza restaurant, you can open an independent store or choose a franchise. If you go the franchise route, the average Domino’s does nearly 40% more revenue than the average Pizza Hut. So if you’re looking to optimize your investment, Domino’s is a great choice.

And then lastly, I think Domino’s benefits from the heuristic of satisficing. This is where you make a choice that will satisfy and suffice, even though it may not be the best possible solution. After a long week, you don't want to cook or think hard about where to eat. You open the Domino's app, tap a few buttons, and order from the couch. And the numbers back this up; data shows Domino’s continues to take market share while other national and regional brands are losing it.

Since Domino’s only has a few dough manufacturing facilities, only owns a few hundred stores, and gets the bulk of its revenue from stores they don’t own, you can probably imagine this business being relatively capital light. Domino’s spends a touch over 2% of its revenue on capital expenditure, a pretty low number for what appears to be a pizza retailer. But what really matters on Domino’s balance sheet is its lack of reinvestment.

It’s not necessarily a bad thing. I mentioned the 15% EPS CAGR over the past two decades. I doubt investors who have held for the last 20 years are complaining, but the interesting thing about the balance sheet is seeing that the business has negative equity. I remember the first time I saw this, thinking, “What the heck am I looking at here?”

But it’s important to understand this isn’t due to financial distress. Negative equity is something you often see in startups that make no profits and therefore accumulate a deficit in book value. Domino’s makes a ton of money, and the explanation is simply that they don’t need to reinvest in the business to grow it. Instead, they’ve opted for shareholder distributions to generate value. When you can meaningfully reduce your share count, you don’t need to grow much to get a reasonable EPS growth rate. Just look at what AutoZone has done over the last three decades.

But while I commend Domino’s for this buyback strategy, I’m hesitant to give them an A grade. And that’s because there have been too many instances of this business using debt to fund buybacks because they felt they could spend more on repurchases than the business generated in cash flow. I’m ok with the occasional use of debt for intelligent capital allocation, provided you can pay it off relatively quickly. But when you add up the shareholder distributions strategy for Domino’s Pizza, it’s obvious that:

This makes me uneasy because if you never escape debt and your business model deteriorates, you're in some pretty big trouble. And with the way Domino’s debt is structured, it’s certainly not favorable for shareholders. They have securitized their royalty streams, IP, and supply chain operations. This offers the benefit of better interest rates (currently at a blended average of 3.8%), but the downside is that shareholders don’t have a claim on much if the business can’t service its debt.

And debt is quite high for my taste. They’re currently at about 5x debt/EBITDA and their covenants let them go to 5.5x.

It’s pretty ironic when you think about it. The debt markets decided that Domino's revenue, as an economic franchise, is durable, predictable, and lendable at near-government rates. And Domino's has used that cheap money to buy back its own stock at a scale its operating cash flow couldn't support. Or, to put it more simply, Domino’s has been converting the credit market's confidence in its durability into equity returns.

But if I’m being honest, this is a system that works well until it doesn’t. And if the company’s current headwinds are permanent, same-store sales continue to decline, and it has difficulty opening new franchises, then refinancing becomes increasingly difficult. And even if they do refinance, the added risk will increase their interest rate.

But it’s not all doom and gloom. The business has been resilient for 66 years and has had only 5 CEOs in its history. Long management tenures usually say something positive about culture and DNA. The current CEO is Russell Weiner, who has been inside Domino’s for nearly two decades. Another barometer of good culture is internal hires and promotions, and Domino’s ticks those boxes as well.

Unfortunately, the rest of the management equation is on weaker legs. Insiders own less than 1% of a company with a market cap of $11 billion. And while the CEO’s pay is heavily performance-weighted, the central target is based around adjusted EBITDA, a metric I have a pretty low opinion of. On top of that, over the last few years, insider transactions have been weighted toward selling, much of it through the exercise of options.

When you consider that Domino’s Pizza has had multiple drawdowns over the past few years, it doesn’t really inspire confidence in investors to see a lack of insider purchases when shares have corrected so significantly. Even Berkshire Hathaway, for a time, owned a meaningful stake in Domino’s but exited earlier this year.

The reason Domino’s first became interesting to me was the classic reason a value investor gets interested in any business. The price dropped. But the next part of figuring out why is where things got really interesting.

First, there was a deceleration in growth. Up until 2022, revenue had compounded at an 11% CAGR over the last decade. But since then, it’s compounded at an anemic 3%. Same-store sales as of the latest quarter are pretty much flat both in the US and internationally. All this has caused the multiple on this business to halve, from about 40x earnings in 2020 to 19x today. Back then, even with decent growth rates, 40x earnings always looked insane for a pizza franchise.

When I compare this business with American Tower, it’s clear how much better American Tower is. It has long-term contracts, switching costs, and pricing power. Advantages just not available to Domino’s. And yet its PE is 24, just a little higher than Domino’s.

There are three areas of this business that I keep coming back to as large risks. The first is simply the debt. If the underlying business stays healthy, it should be okay, but the lack of growth and flat same-store sales don’t put my mind at ease. Second are health trends, specifically around GLP-1 drugs. Consumers are drifting towards being healthier, and GLP-1 drugs are only getting cheaper and more widely used, decreasing people’s appetites. None of these scream “tailwind” to me when it comes to Domino’s Pizza.

Then finally we come to the aggregators. In that sense, it cuts both ways. Domino's gives up margin to acquire customers through aggregators like Uber Eats and DoorDash. And if they can’t onboard these new customers onto their own app, they’re stuck with a lower-margin part of their business as a potential growth driver. But if they can wow new customers, it could be a good growth tailwind.

As negative as you may think I’ve been so far, this business isn’t really a melting ice cube. The business has a rewards program with 36 million members. The rewards program is pretty good, and I can attest that it’s worked for me many times before. This app gives Domino’s vital data it can use to generate more sales.

But the real lever for Domino’s to continue growing is the most boring one: more stores. Store count today is around 22,500 and has compounded at about 6% annually since 2012. Yes, the US is getting saturated, but the rest of the world is not. And if the master franchisees see as much success with the fortressing strategy abroad, there’s no reason to think they can’t maintain this new store-opening growth rate.

My base case is simple, which I very much appreciate. For this business to succeed, they only need to do a few things: sell more pizzas each year, open more stores, and nudge up same-store sales. If they can do all those things, shares will be worth more in the future than they are today.

I assume revenue will grow by about 5.5% over the next five years. This is a touch above the most recent trend. But I’m assuming consumer demand remains; the aggregator channel brings in more loyal customers, who Domino’s wouldn’t otherwise get. I also assume growth of about 750 new stores per year.

Then I hold EBITDA margins flat at 20.5%, in line with their current numbers. This seems very doable over the long term, especially if they continue closing corporate-owned stores and allow royalty revenue to make up an increasing percentage of their overall revenue.

Lastly, I apply a 17x EV/EBITDA multiple, add a 20% margin of safety, and arrive at a weighted average value of about $317. Given that this is still below the current stock of $336 and that the returns are well below our hurdle rate in both the base and bear scenarios, we will be passing on Domino’s Pizza.

To listen to our discussion of Domino’s, or for more company Deep Dives, check out our podcast here.

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