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Domino's: Financial Ratio analysis

Learning Portfolio Part A – Case Study 

Choose a hospitality company and prepare an analytical & comparative case study of investing potential in the common stock this company over three years (2015, 2016, 2017). Your report should be no longer than 2,500 words.

Examples:

· Restaurants

· Theme parks

· Cruises

· Hotels

· Airlines

· Cinemas

· Spas

· Golfs

Your analysis must be built with a horizontal analysis of financial ratios’ description,

explanation and evaluation.

The ratios discussed should include (when possible):

• Current ratio

• Quick ratio

• Accounts receivable turnover

• Number of days’ sales in receivables

• Inventory turnover

• Number of days’ sales in inventory

• Debt to Assets ratio

• Debt to Equity ratio

• Number of times interest charges are

earned

• Profit Margin ratio

• Return on Assets

• Return on Equity

• Earnings per Share on common stock

Be sure to address areas of financial risk, capital structure and profitability.

Graphs and colour must be used to assist in summarising key points of your analysis and will

make your analysis more accessible.

Essential Text and materials:

Warren, C.S., Reeve, J.M., & Duchac, J.E. (2016) Managerial Accounting. Cengage

Learning, 13th ed.

http://www.nasdaq.com/

http://www.sec.gov/


Answer

Financial Ratios Analysis

Domino's

Executive Summary

The main purpose of this document is to determine the Financial Ratio analysis using the technique which is frequently used for analysis is horizontal analysis of financial ratios. 

Financial analysis or financial statement analysis involves evaluation of a project or a business. This evaluation aims to assess the feasibility and profitability of the subject. The evaluation can be done by using various tools, one of the main tools being financial ratio analysis (Kieso, Weygandt & Warfield, 2007).

This assignment will analyse Domino’s company performance during 2015-2017 with the help of horizontal analysis of financial ratios. Horizontal analysis involves comparison of financial information over various periods. Alternatively, comparison can be made using financial ratios over various reporting periods (Warren, Reeve & Duchac, 2016).

The following pages provide an analytical and comparative financial analysis for one of the largest pizza restaurant chain in the world, Domino’s. The sections will provide key financial ratios, segregated basis their purpose. The sections will provide a basic overview of how and why the ratios are calculated and how they can be interpreted. Additionally, it will also discuss how Domino’s corresponding financial ratios are placed in tandem with the information available in corresponding year’s annual report 

Company Overview

Domino’s (NYSE: DPZ) was founded in 1960 and is headquartered in Ann Arbor, Michigan. The company’s mission is to become number one in the field, which was achieved in February, 2018 when Domino’s became the largest pizza seller worldwide.

Domino’s started with one small store in 1960 but expanded quickly with 1978 being the 200th store’s opening. Currently, there are over 14,800 stores in over 85 countries, with more than 5,000 outside the US with around 14,100 employees across segments. The company mainly operates through franchise model, with the company being franchise-owned to the tune of 93% (Company History, 2018).

Industry Overview 

Domino’s is part of Quick Service Restaurant (QSR) pizza industry which is large and fragmented. The main competitors include Pizza Hut, Little Caesars Pizza, Papa John’s as well as lot of local players. The top four players, including Domino’s dominate major share in various segments of QSR pizza category. 

QSR industry in the US is huge at $290.2bn. The second-largest of this is the QSR pizza category which mainly consists of delivery, dine-in and carryout. Within ten years from 2007 to 2017, the QSR pizza industry has grown from $32.9bn to $36.0bn. 

The industry has a lot for scope for growth, especially outside the US, given the convenience and historic successful performance (Company Annual Report, 2017).

Business Segment-wise performance

Within Domino’s, the business segments as reported are: domestic stores, international franchise and supply chain which have been discussed in following paragraphs (Company Annual Report, 2017).

Domestic Stores

Domino’s domestic stores refers to its stores in the United States, both franchise operations as well as company owned stores. Given the business model, the major revenue is from more than 5,000 franchised-stores located in US. Additionally, the Company also has around 400 company-owned stores in US.

Overall, the domestic stores segment accounted for more than 30% of the consolidated revenues ($842.2mn) in 2017. 

International Franchise

As of 2017, Domino’s had a presence in 85 international markets through its network of 9,269 franchise-stores in these locations with majority of them operating under master franchise agreements. The main source of revenue from this segment is royalty payments based on retail sales. The segment accounted for more than 7% of consolidated revenues ($206.7mn) in 2017.

Supply Chain

This segment operates various centres required to cater to Domino’s product demand. This includes dough manufacturing centres, thin crust manufacturing centres, vegetable processing centres, food supply chain centres and centre providing equipment and supplies to certain Domino’s stores. This also includes leasing of tractors and trailers. These are mainly located in the United States and some are also in Canada.

As of 2017, the supply chain segment accounted for over 63% of consolidated revenues ($1.74bn). Profit –sharing arrangements are offered to the franchisees who purchase all of their food for their stores from Domino’s supply chain centres.

Ratio Analysis

This section is aimed at determining how Domino’s has performed by using horizontal financial ratio analysis methodology. The ratios have been categorized basis their purpose and main categories include Solvency ratios, Leverage Ratios, Turnover Ratios, Profitability Ratios. Each category will discuss the purpose with which these ratios are calculated and how they can be interpreted. Then within each category, few key ratios will be discussed. The discussion will, in turn, include the utilization of that particular ratio and how Domino’s has performed with respect to the ratio during 2015-2017.

For reference, the following table provides a snapshot of various ratios for Domino’s:



2015
2016
2017
RATIO ANALYSIS
Liquidity
 

 
Current Ratio %
161%
160%
123%
Quick Ratio
     1.47 
     1.50 
     1.13 
Efficiency Ratios



Accounts Receivable Turnover (days)
-
20.58
20.81
Asset Turnover Ratio
-
3.18
3.26
Inventory Turnover Ratio (DAYS)
-
6.16
5.69

 

 
Leverage Ratios
 

 
Debt to Assets Ratio%
252%
280%
305%
Debt to Equity Ratio %
-123%
-124%
-116%
Interest Cover (times)
3.98
4.08
4.13
Total Liabilities/Total Assets
304.5%
325.1%
362.9%

 

 
Profitability
 

 
Net Margin %
8.15%
8.70%
8.68%
ROA %
27.3%
24.1%
30.0%
ROE %
-13%
-11%
-11%

Liquidity Ratios

Also known as solvency ratios, they assess the business’s capacity to meet its liabilities in short-run. There are two main solvency ratios (Fridson & Alvarez, 2011):

  1. Current Ratio: The formula for this ratio can be presented as Current Assets divided by Current Liabilities. Domino’s has a current ratio which is consistently above 100%, indicating that it can meet its short-run obligations easily. However, too high a current ratio indicates that the funds could have been deployed elsewhere in a more profitable manner. To this effect, Domino’s current ratio has reduced from 161% in 2015 to 123% in 2017 which indicates effective utilization of available resources. The ratio is still very strong.
  2. Quick Ratio: This ratio is similar to above ratio, the only difference being related to inventories. The formula for this ratio can be presented as Current Assets less Inventories, divided by Current Liabilities. This is also called acid test ratios and indicates capacity of business to meet short-run obligations immediately. Domino’s has a consistently strong quick ratio which has declined slightly in 2017 (0.89) but is still quite good.

Turnover Ratios

Turnover ratios evaluate the turnaround time for a line item, such as inventory or assets. These are also known as efficiency ratios as they indicate the efficiency with which the line item (inventory or assets) are being utilized to generate revenue. The three main turnover ratios are (Weston, 1990):

  1. Inventory Turnover Ratio: This ratio is used to understand how fast the inventory is replaced or sold over a period of time. It is calculated as sales divided by average inventory. It can also be converted into days to get an idea of how many days it takes to replace the inventory. Domino’s inventory turnover ratio in 2016 was 6.16 days which further reduced to 5.69 days in 2017. This shows efficient management of inventory. The low inventory turnover is acceptable given the nature of business, due to which most of the inventory is perishable in nature. 
  2. Asset Turnover Ratio: This indicates the sales or revenue generated with respect to the assets value of the company. Higher the ratio, better it is as it indicates that more revenue is generated per dollar of assets. Domino’s had an asset turnover of 3.18 times in 2016 which increased to 3.26 times in 2017. This indicates more sales per dollar of assets is being achieved.
  3. Accounts Receivable Turnover Ratio: This ratio indicates a company’s effectiveness to collect the debt from debtors. It is calculated as sales divided by average accounts receivables and can be converted to days by dividing this by 365. Domino’s has an accounts receivables ratio of around 20 times which indicates fast moving debtors and effective collection process in the company.

Debt Ratios

These ratios are also known as leverage ratios and indicate how a company’s capital structure is formed. These ratios are also known as gearing ratios. High debt or high leverage in the capital structure indicates that a company has taken more risk by procuring cheaper debt funds. This is known as high gearing effect. Low debt in capital structure indicates a company is relying on expensive but less risky equity and retained earnings, also known as low gearing. A company should have appropriate proportion of both components in the capital structure so as to attain maximum profitability and risk profile. Main debt ratios are (Vandyck, 2006):

  1. Debt to Assets Ratio: This ratio indicates the proportion of debt in a company’s capital structure with respect to the total assets of the company. It can be calculated as Long term debt divided by the total assets of the company. A high number indicates high debt in capital structure and vice versa. Domino’s debt to assets ratio is extremely high at 305% in 2017. It has been consistently increasing since 2015 when it was 252% to reach this level. The company went through recapitalization in 2012 and then in 2015 leading to such high debt in capital structure. This restricts the company as it has created fixed obligations for itself in form of interest and principal repayment.
  2. Debt to Equity Ratio: Similar to above, the debt to equity ratio indicates debt in capital structure with respect to equity. Domino’s has debt to equity ratio of -116% in 2017 as compared to -123% in 2015. This indicates increased reliance on debt for the company to grow and may create pressure on the company to increase profitability.
  3. Interest Coverage Ratio: This ratio indicates a company’s ability to meet its fixed interest obligations through its profits. A high ratio indicates a company has ability to meet its interest obligations and vice versa. Domino’s has a healthy interest coverage ratio of 4.13 times, despite heavy debt in the capital structure which indicates it has capability to meet the fixed obligations.

Profitability & Return Ratios

These ratios are the most important for an investor of a company as they indicate profitability potential of the company and provide a bird’s eye view. As the name suggests, these ratios indicate the profit earning capacity of a business with respect to various expenses and costs (Vaughan & Vaughan, 2007)

  1. Net Margin Ratio: As the name suggests, this ratio indicates a company’s net profit with respect to its revenue or sales. It indicates profit earned per dollar of sale. Domino’s net margin ratio has been hovering around 8.68% in 2017 and was 8.15% in 2015. This indicates slight improvement although, given the increase in sales over the same period, it is not much. This may be attributed to increased costs that have eaten into profitability and also price pressures due to industry being competitive.
  2. Return on Assets Ratio: This ratio indicates profitability per dollar of assets employed. Domino’s has witnessed good increase in return on assets in 2017 when it stood at 30% as compared to 27.3% and 24.1% in 2015 and 2016, respectively. This indicates efficiency in the operations.
  3. EPS on common stock: EPS is the earning for equity shareholders or owners of the company. This is the key measure for shareholders as it indicates how much they have earned. Basic EPS for Domino’s has consistently increased from 2.96 to 3.58 to 4.41 during 2015, 2016 and 2017, respectively.   

Outlook

QSR industry, especially the QSR pizza category has great potential to grow due to the inherent convenience to the consumers. It has great scope to expand internationally.

However, at the same time, the industry is very competitive and fragmented. Apart from the top players, there are multiple local competitors as well. This may exert price pressure in top players which will impact the top line. The food material costs are also an ongoing area that requires attention as food price fluctuate a lot. Additionally, the competition is also in terms of acquiring qualified franchisee that meets the eligibility criteria. Without this, expansion, especially internationally, is very difficult. From consumer’s perspective, the companies have to continuously innovate their food products and tastes so as to make them suitable to customer preferences that are ever-changing.

Conclusion

Domino’s stock price soared by almost 19% during the year 2017. This is presented in the following graph:

Domino's stock in 2017



It can be seen that Domino’s stock outperformed S&P 500 index till the third quarter. This is especially significant given that Papa John’s stock fell by more than 30% during the year. The main reason for success of Domino’s chain as compared to rivals is their low cost business model and strong use of digitalization. The company is already a leader in delivery segment and is posed to capture more market share (Kalogeropoulos, 2018).

Domino’s is already a leader in the market on the basis of global retail sales. The brand has strong market affiliations, such as with Coca Cola. The brand itself has tremendous recall value, which, in turn, is aided by huge advertising budget. Further, the business model which is based on royalties through franchise and company-owned stores as well as supply chain revenue, has successful track record. The company continues to innovate, both in terms of product and technology. The only thing to be noted is high debt component in the structure that may cause pressure on profitability, especially given the cost-conscious economic environment, which, in turn, will put pressure on price of various products. All of this provides a positive outlook for the company in coming years.


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