In this MarketFoolery video segment, host Chris Hill and Supernova and Rule Breakers' David Kretzmann slice up the details from Domino's (NYSE: DPZ) second-quarter earnings report, and the tasty toppings were unevenly distributed. While its domestic performance remains best in class, it missed its targets overseas. Why? Well, let's just say that Europe -- and specifically the U.K. -- is less in the mood for an ultimate pepperoni lately. Shares fell about 10%. So how should investors respond?
A full transcript follows the video.
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This video was recorded on July 25, 2017.
Chris Hill: Domino's Pizza getting hit despite the fact that second-quarter same-store sales in the United States were up more than 11%. Those are phenomenal numbers. But unlike McDonald's, where we saw this great number globally, big disparity with Domino's Pizza. Looking great in the U.S., but internationally, significantly lower.
David Kretzmann: Yeah, international comps were up 2.6%, which isn't bad, and that's actually 94 straight quarters of positive comps internationally. So I don't know. There's a lot to worry about here, Chris. I don't know if they really cracked the code yet internationally. We'll have to watch closely. But it seemed like the slowdown from what management mentioned was generally driven by Europe, especially the U.K. They mentioned that there's weaker consumer confidence. They weren't using that as an excuse. They said, "We need to do better, we need to find ways to reach customers where they're at." So this isn't something I would be overly concerned about. Management has stated that their long-term goal over the next three to five years is to grow international comps between 3% and 6%. So when you miss that hurdle pretty soon after mentioning those long-term projections, I think it's understandable for the market to be a little skeptical, especially when the valuation is lofty. The stock is still trading around 40 times trailing earnings. The expectations are high.
I think Domino's is still clearly the best of class in the restaurant space, so I would treat this more as an opportunity to potentially start a position if you don't already have one, or maybe look to add a little bit to your position if you have that long-term time horizon. But when you have such a lofty valuation multiple, it's hard to put out perfect results each quarter, which is really what it requires. But looking longer-term, I think Domino's is still in a great position to snap up market share. They're the clear innovator when it comes to online ordering, digital ordering, delivery, all of that stuff. And the leadership under Patrick Doyle has just been incredible over the past several years. So I think there's still a lot to like here. EPS grew 35% this quarter. Domestic same-store sales up almost 10% for the quarter, which is just unheard of in this restaurant environment. So yeah, the international comps will be something to watch, but 23 and a half straight years of positive global comps, I think Domino's has cracked that code. I think they know what they're doing, and they can probably turn that around pretty quickly.
Hill: Yeah, I was probably being a little tough on them. But that is the noteworthy number comparison when you look at this quarter. The U.S. same-store sales are so great, and to see them drop off to that degree, I think that's why it's noteworthy. But as you said, this is a stock even with the drop today -- it's down about 8% this morning -- even with that drop, it's still up 33% over the past year. And you mentioned Patrick Doyle, another great example of a CEO who, when he takes over, comes in and really shines a light on the challenges that the company is facing. In the case of Domino's, Patrick Doyle was the one who really pushed the idea, "You know what people say about our pizza? It's not very good. How about we focus on making the pizza better?" And not only did they do that, but they did the whole ad campaign around that. And not only is the pizza better -- is it the best pizza in the world? No, but it doesn't have to be. They made it better, and they made sure that they communicated to people, "We hear what you've been saying, and we're trying to make it better."
Kretzmann: Yeah, a lot of things are going well for Domino's. Another thing that they really perfected is that digital ordering system.
Hill: I was going to say, the mobile.
Kretzmann: Yeah. It's such a sticky process for the consumers. Once you have that app downloaded and you have your account created with Domino's, it's easy to just go back and repeat that order every week, every month, or whatever the case may be. So you're seeing more and more of those orders continue over time with repeat customers. They've also done something with, I think by this point, they finished it up, or they're close to finishing it up, the whole reimaging process of their stores. Domino's is another company where they're almost entirely a franchise operator. But most of their franchisees in the U.S. have completed a reimaging of their stores where, if you walk into a Domino's today, it actually looks a little bit more like a fast-casual restaurant, where you can see the pizza being made, you can see the ingredients, and it's just a better customer experience. Obviously, the majority of their business is still takeout and delivery. But when you do walk into the stores, it's a better experience. They've noticed a sales lift from the stores once they transition to that reimaging.
I think the market is something to think about as investors, if we eventually do see a deceleration in domestic same-store sales, which will happen at some point, even though the last couple years have been incredible for Domino's, which is really impressive considering the restaurant environment, right now the expectations are still very high for the company. So when you see that deceleration in same-store sales, it wouldn't be a surprise to see the stock get hit. We know it can happen internationally. The same quarter last year, international same-store sales were up 7% or so, now growing under 3%. Maybe analysts are a little bit worried about what happens domestically over the next year.
Hill: You mentioned the mobile. I think it's easy to look at mobile ordering just in terms of the technology. And that makes sense, particularly if you've ever used any app to order anything. The user experience matters a great deal. But I think what's important to recognize in the case of Domino's is, it's not just that they created this great mobile ordering platform, but that they realized, "If this works, this is going to mean more business, this is going to mean greater throughput, and this means we have to be able to handle it in the kitchen." So it's not just a matter of getting the mobile app experience right; it's a matter of making sure that you're prepared on the back end to fulfill an increase in orders. That's something -- not to pick on them -- that Starbucks hasn't quite figured out yet. And they've called that out themselves in the last couple of quarters, that they're getting more and more mobile orders, and it's leading to a little bit of a mosh pit when people go to pick up their stuff.
Kretzmann: Right. It's a great problem to have, but it's still an issue.
Hill: It's still a problem.
Kretzmann: Still a problem, yeah. And it's something to figure out. But looking at Domino's and McDonald's, I think it reinforces the importance, as an investor, to be patient with these companies. I can think of a couple restaurants right now that are going through tough times of their own. But when you have a proven operator, generally strong leadership, or the potential for new leadership to step in, it doesn't actually take all that long for a concept to turn around. Think of Panera in 2014. Not a whole lot of fans of Panera in the investing community a few years ago. Within three years, when they took a step back and recognized, "There's a lot of stuff we can improve here," including that digital and online order experience, it only took two or three years for the company to become a darling in the restaurant space and turn it around. With restaurants in particular, when you have a company with a proven brand, a proven record and leadership that's either willing to change or the potential for new leadership to step in, in the case of McDonald's and Domino's, I think, as an investor, it really pays to be patient with those kinds of companies. You don't want to give up when they're still trying to figure things out.
Hill: When you're ordering pizza, is there anything that you add on your own? Regardless of what the topping is, is there any kind of, whatever I order, I'm going to add a little Parmesan cheese, or a little fresh basil, or anything like that on top?
Kretzmann: I'll sometimes add extra cheese when I'm feeling that need for more calcium, Chris. It's all about the calcium. What about you?
Hill: I go a little crushed red pepper, just to add a little bit of heat on there. But yeah, more cheese is always a good thing.
Kretzmann: Yeah, it's hard to go wrong with that.