Sean Dunlop, CFA, equity analyst, Morningstar Research
Domino’s Pizza (NYSE:DPZ) and Papa John’s (NASDAQ:PZZA) are two of the largest pizza restaurant brands in America.
The pandemic created chaos in the convenience food segment and now the stage is set for the winners and losers to be sorted out.
Sean Dunlop, CFA, is an equity analyst on the consumer team for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc.
He covers restaurants and e-commerce stocks.
His detailed analysis uncovers the value difference between Domino’s Pizza (NYSE:DPZ) and Papa John’s (NASDAQ:PZZA).
Before joining Morningstar in 2020, Dunlop worked with All Nations Sports Academy, a small nonprofit in the Houston area.
Dunlop holds a bachelor’s degree in business economics and Spanish from Wheaton College.
The background to Sean Dunlop’s Domino’s Pizza (NYSE:DPZ) vs. Papa John’s (NASDAQ:PZZA) pick originates the in restaurant apocalypse in the COVID 19 pandemic.
“It’s certainly been an interesting couple of years to be a restaurant analyst.
Rewind to March 2020, and it was effectively impossible to set foot in a restaurant dining room.
So we saw unprecedented levels of comparable store sales declines and a lot of companies that were reporting bankruptcy.
From a small business perspective, you had a lot of independent restaurants that were tapping PPP loans to stay afloat.
We probably lost somewhere between 10% and 15% of restaurant industry capacity by units.
It was a really brutal time for the industry, as it was for a lot of other industries and for consumers in general.
Since then, we’ve seen a furious rebound.
In 2021, we saw a lot of pent-up demand and revenge spending driving pretty much a full recovery in sales.
A lot of companies like Domino’s Pizza (NYSE:DPZ) were posting crazy comparable store sales figures in the mid-teens, and restaurants were posting commensurately higher operating profit margins despite a lot of brewing inflationary pressure in things like restaurant equipment, labor and food costs.
Fast forward to 2022, and we saw the costs catch up to and exceed outsized industry sales growth.
Restaurant multiples compressed, and the industry sold off hard.
Now, I would say we are somewhere in between.
Sales growth looks strong as you stack it back to pre-COVID, to 2019 levels.
Restaurant profitability has mostly, but not fully, recovered.
And while consumers continue to spend healthily, there are increasingly some concerns about price sensitivity and declining industry traffic, which remains quite a bit lower than pre-pandemic.”
So which is the stock to buy, Domino’s Pizza (NYSE:DPZ) vs. Papa John’s (NASDAQ:PZZA)?
“It’s a good question.
I would say it depends on where you’re standing.
For a lot of the large publicly traded restaurants, online ordering has been largely incremental, and it has increased the number of transactions that a store can service, given that you don’t actually have to seat those customers.
In some ways, those orders have been responsible, as you think about the delivery channel specifically, for the lion’s share of industry growth, and call it the burger category, or call it pizza or wings.
They do tend to be incremental.
They do also tend to be higher cost.
The net effect is probably positive.
But maybe not as positive as people would think.
The downside is that the size of the proverbial pie is relatively fixed.
So if you’ve got companies like Chipotle (NYSE:CMG) that now see 40% to 45% of sales come through digital channels, or companies like Yum! Brands (NYSE:YUM), which owns KFC, Taco Bell, and Pizza Hut, which is now generating 45% of system wide sales through those digital channels, those sales are coming from somewhere else.
And we have mentioned that industry traffic is down.
The number of occasions served by the restaurant industry are down relative to pre-pandemic.
In many cases, that means that smaller operators who are typically paying higher commission costs and who may be a little bit more reluctant to hop on a DoorDash or Uber Eats or Grubhub, are bearing those costs disproportionately.
So it’s a nuanced question, it depends on where you’re standing, but for the largest operators, it tends to be a net positive.”
The final answer between Domino’s Pizza (NYSE:DPZ) vs. Papa John’s (NASDAQ:PZZA) is Domino’s Pizza (NYSE:DPZ).
“I would point out that Domino’s Pizza (NYSE:DPZ) has had a particularly interesting narrative, as you look back to COVID.
They saw some of the best comparable store sales growth in the company’s history strung together.
At one point, I believe, more than 10 years of positive comparable store sales growth in the United States and more than 100 quarters of positive comparable store sales growth in international markets since the firm’s 2009 turnaround up until sort of late 2021 or early 2022, when the narrative reversed.
Obviously, pizza lent itself very well to a lockdown scenario where it could be contactless, where consumers were already pretty familiar with ordering that category through digital channels.
So, brands like Domino’s Pizza (NYSE:DPZ) and Papa John’s (NASDAQ:PZZA) benefited disproportionately.
As those volumes started to normalize, as consumers could go back to dining and restaurants, as we’ve seen sort of downtown traffic normalize, Domino’s Pizza (NYSE:DPZ) sold off very hard from a peak in the neighborhood of $560 per share to a trough in the neighborhood of $288 or $290.
And then, as the firm inked its first ever development agreement with Uber Eats, with a delivery aggregator, shares shot back up and are trading kind of in that $370, $380 range, pretty close to our fair value estimate. So that’s been an interesting narrative.
We do for the first time see some value in the publicly traded companies that we cover. Starbucks, McDonald’s and Yum! Brands are particularly attractive.
They trade at about 12%, 10%, and 10% discounts to our intrinsic valuations respectively. But there are interesting idiosyncratic concerns to consider for each.
McDonald’s, for instance, is navigating a period of pretty outsized turmoil with its franchisees, particularly in light of a recent California agreement that’s going to see hourly wages tick up to $20 per hour in that market.
Yum! Brands is having to navigate sort of a domestic turnaround of its Pizza Hut and KFC businesses.
Starbucks is dealing with increasing competitive pressure in the quickly growing Chinese specialty coffee market and also navigating what’s been a pretty turbulent geopolitical and economic environment in that region, although I think investors tend to overestimate the actual contribution of China to Starbucks’ consolidated operations, it’s really only about 10% of total sales today and a smaller component of profitability.
So, it’s a tricky question to answer, but that’s kind of what’s happening in the restaurant space right now.”
Get the complete picture on Domino’s Pizza (NYSE:DPZ) as well as a range of other restaurant stocks by reading the entire interview, exclusively in the Wall Street Transcript.
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