Domino’s Guidance Gives Investors Indigestion

Wide-moat Domino’s DPZ trimmed its three-year systemwide sales growth (now 4%-8%, from 6%-10%) and unit development (to 5%-7%, from 6%-8%) guidance this morning, sending share prices tumbling 11% on the initial reaction. We believe that the market’s concerns are overblown, with the pizza chain’s admission validating our prior thesis; worse restaurant-level profitability in tandem with higher construction and financing costs should drive a medium-term contraction in unit development for most operators—Domino’s is simply our first company to publicly admit it. We expect only modest changes to our own estimates, which now contemplate 7% and 6% annual system sales and unit growth through 2025 (from 8% and 6%), respectively, leaving our $397 fair value estimate effectively unchanged.

The firm’s quarterly results were mixed, with $1.39 billion in sales aligning with our forecast, though $4.43 in diluted EPS narrowly missed our $4.66 estimate. Strong cost containment on the G&A side (we forecast growth of just 3%-4%) in tandem with the margin accretion from refranchising 114 stores should drive modest operating margin expansion in 2023, by our estimates, with our 2023 forecasts now contemplating growth of 0.6%, 5.3%, and 1.6% in sales, operating profit, and diluted EPS, respectively. The year figures to be challenging for restaurateurs, with our expectations for limited pricing power as consumers navigate inflationary headwinds suggesting very limited restaurant margin recapture.

We view consumer trade down from the firm’s premium delivery channel as unsurprising and continue to see its carryout business (now representing 40% of U.S. sales) as the key growth engine. Domino’s compelling four-wall economics should defend its growth narrative, with cash ROI around 35% and strong international uptake remaining alluring. With shares trading at about a 20% discount to our intrinsic valuation intraday, Domino’s remains our top pick in the restaurant industry.