Dominos Pizza UK & IRL plc - Case Study Example

Analysis of Domino's Pizza UK & IRL plc Core Activities and Operations Domino's Pizza UK & IRL plc owns Domino's Pizza Group Ltd, which holds the master franchise licence to own, operate and franchise Domino's Pizza stores in England, Scotland, Wales, and Ireland. Domino's Pizza is a US-founded and based company that specialises in the delivery of freshly-made, home-delivered high quality pizza. The first store in the UK opened in 1985 and in Ireland in 1991 (Domino's, 2007, p. 2). The company takes orders for its products through the telephone or the Internet. The number of stores increased from 407 to 451 in 2006, accounting for increased system sales to 240 million from 200 million in 2005. Profits before tax rose 28% to 14.3 million. Sales through the company's website also grew 44% to 20 million, up almost 50% from the previous year. The company focuses on selling only one product - pizza - and throughout the year, as it has been doing in the UK and Ireland in the last 20 years, minor improvements are made to get the product to the customer in the shortest possible time. In 2006, the company launched an 'out-the-door' campaign that cut the time from order taking to the start of the delivery down to 15 minutes. Thus, by combining the quality of the product with speed of service, Domino's was bale to increase its repeat orders, which is a key driver of like-for-like sales increases that, at least in theory, could last forever. The company leads the pizza delivery market in the UK and Ireland, and its stores rate amongst the most efficient and successful in the Domino's system worldwide (p. 2). Another unique feature of the company is that its stores are run with local business partners who manage them as part of the local business community with which it has established loyal partnerships. Profitability Ratios Using data from the 2006 Annual Report gives the profitability ratios as of 31 December 2006 (see Appendices A, B, and C): Profit Margin = 15.16% (13.78% in 2005) The value of the profit margin was calculated from the adjusted profit before tax amounting to 14.402 million whilst total sales amounted to 94.965 million. The profit margin for the year is higher than the previous year's figure of 13.78% from profits of 11.254 million on sales of 81.66 million. The profit margin went up by 10% on the basis of several possible factors like better marketing, improved economic conditions in the UK and Ireland where the economy is growing each year by 3-4% (Heritage, 2007, p. 381). The margins for the Group most likely reflect the profits earned from selling to franchisees the ingredients used for making pizzas and from the franchise fees paid by those who opened new stores during the year. Offhand, 13-15% margins are rather small for a food operation, where profit margins are in the range of 20-30% as shown by the margins of McDonald's (2007, p. 20) in the last eleven years, which means that Domino's gets most of its profit margins from franchise fees and not from sales of ingredients or pizzas through its own stores. As the Domino's report also shows (p. 27), the company spends 14 million on administrative expenses and 8 million for distribution. Asset Turnover = 5.19 times (3.61 times in 2005) The asset turnover was calculated using the sales figure of 94.965 million and the total capital employed of 18.265 million which is the total assets less the current liabilities as clearly stated in the balance sheet (p. 30). This means that every 1 invested in the company's assets returned sales of 5.19 or over five times the total capital employed in the business. This figure is high, and it has increased quite substantially since the previous year. This figure shows that the company generates revenues with a small amount of assets. This is quite expected given that the main business of the Group is to distribute franchises, carry out quality control processes, and plan the marketing of a product portfolio that is focused on pizzas. The increase from 2005 to 2006 is also interesting, a positive development showing that the management of the company was improving its efficiency in generating sales even as it brought down the value of its assets from 22.62 million in 2005 to 18.265 million in 2006. This is quite remarkable because the total picture painted for the year is one where the management shrunk the balance sheet by 19%, increased sales by 16%, and improved margins by 10%. Return on Total Capital Employed = 78.8% (49.8% in 2005) The numbers are huge! With capital employed amounting to only l8.265 million, the company was able to generate sales of 94.965 million and profits before tax of 14.402 million, almost the same amount as the capital employed. The 78.8% ROCE in 2006 is a substantial increase over the previous year's figure. The ROCE measures the relationship between the profit generated and the total worth of the business, which is the difference between the sum of the fixed and current assets amounting to 18.265 million. The figure, however, is expected because profit margins and asset turnover figures are high, having increased substantially since the previous year. This shows that the management is becoming more efficient in getting rid of non-performing assets and ensuring that the assets it is managing are managed properly, generating higher sales and margins. The ROCE also shows that investments in the company are giving better returns than other investments. Qualitative Analysis of Financial Statements 866 The annual report of the company is like its pizza, not too thick at 67 pages but with enough freshly gathered ingredients that make for an appetising read by actual and potential shareholders. The cover utilises the company's red, white, and blue logo. The wordings used are simple, easy to understand, and devoid of MBA or financial engineering jargon. There are photos that serve a marketing purpose, such as boxes of pizza stacked one on top of the other, and some boxes opened to reveal nestling within a piping hot, freshly-made round of pizza that is ready for delivery. The CEO was likewise straightforward that impressive though its record of 46 store openings was in 2006, it was short of its target of 50 (p. 6). Equally impressive is its admission that planning new stores is a lengthy process, but the company should have known this, which means that there are some inefficiencies present in its operating teams. It may have been possible, though, that the delays in strategy execution may have been due to the laws and regulations that abound in the UK and that affect its business sector, but Domino's should know how to cope with that after over 20 years of operations. Nevertheless, the over-all impression given by the reports of the Chairman and the CEO is one of confidence that these people know what they are doing, and are honest enough to admit mistakes that may have been committed or objectives that were not attained without blaming a list of factors. This means the executives accept responsibility and are not afraid to do so. Amongst others, two interesting pieces of information that nestle within the report are highly informative of the company's performance. First, the company's average store per franchisee increased from 2.7 in 2005 to 3.0 in 2006 (p. 7), which means that franchisees love the company because its business is profitable, not only for the company but more importantly for the franchisee. Therefore, they have more than one store to own and operate. Second, a page (p. 14) in the report was devoted to a discussion of the total eating out market in the UK, estimated by Mintel at 29 billion in 2006, of which 1.3 billion is attributed to the home delivered market. This is the share of the fastest-growing segment of the market that Domino's aims to capture; the figures show that the company is not only getting there but, more importantly, grabbing a bigger share of this market with annual sales of 240 million. The financial portion of the report opens with the remuneration report on its executives. One detail that is rather difficult to understand is that several directors (the Chairman, CEO, and a non-executive director) receive as part of their compensation some shares in the trust fund that owns Domino's UK & IRL, and that the beneficiaries of these are the adult children of these directors (p. 22). These are a way of evading personal taxes, which is understandable, but why make the children the beneficiaries There must be another reason for doing so, and such is not clear from the report. The company's relatively small size and multiple ownership layers by trust funds, investment and commercial banks, and by several families make corporate governance an important issue, because any potential shareholder (the company's shares are traded in the Alternative Investment Market) would want to know how the assets would be distributed in case of a corporate meltdown. But the report devotes only a paragraph with nine bullet points for this issue (p. 23), which should make potential investors wary of what the directors may be up to. The report is more generous in its discussion of corporate social responsibility and charitable donations, devoting five terse paragraphs to the issue (p. 24). Until one takes a look at the financial statements, the reader would think that the report is for a company that sells 240 million worth of pizza yearly, but that is wrong. The report is for the Domino's Pizza Group, which has revenues of only 95 million, a profit before taxes of 14 million, Group assets of 8.6 million (p. 30), and Company assets of 9.4 million (p. 31). There emerges therefore a different picture that is confusing: which performance is being discussed in the report Adding to the confusion is Note 1 to the financial statements which state that the Group accounts consolidate the accounts of Domino's UK and IRL and its subsidiaries, when the figures show that the figures in the Group accounts are less than the Company accounts and that the Company is what owns the Group (p. 2). By the end of the report, the reader understands a glimmer of what the report is all about: it is the financial performance of a company that owns the franchise and that collect franchise fees and payments for the ingredients bought from the Group by the franchisees that eventually sell the pizza. The Group also takes care of the marketing and advertising costs and for selecting the franchisees. This becomes clear once a first reading of the report is made. A second reading would be needed to understand the details better. Usefulness of Information in Financial Statements The report is useful for those who want to own a part of the "holding" or Group company that owns some stores but whose main task is getting franchisees and supplying stores with the ingredients. This is a good way to make money, because just by selling the ingredients, the Group already makes money from margins and operating efficiency, even if the pizzas do not get sold. It is the franchisees problem to sell the pizza, not the Domino's Group's. There is nothing wrong with this scheme. In fact, it is a profitable operation and one that insulates the company from the troublesome business of running hundreds of stores. It owns some itself, but much of its activity is dealing with 100-plus franchisees who invest funds to put up and manage stores. Such a scheme also insulates the Group from economic downturns that may hit certain regions or parts of the country, allowing it to diversify its business portfolio. Though some franchisees may lose money if, say, a factory closes down in some remote town in the UK, Domino's Group would not have to lose money, since it can recover these loss of sales by, perhaps, higher sales in other parts of the country that may be going through an economic boom. The information in the reports is useful in understanding the business, but some portions of the report could have been much clearer. Reference List Brigham, E. F. & Davies, P.R. (2004) Intermediate Financial Management, 8th Ed. London: Thompson. Domino's Pizza UK & IRL plc (2007) Take a fresh look: Annual report for the 52 weeks ended 31 December 2006. Milton Keynes: Domino House. Heritage Foundation (2007) Index of economic freedom 2007. Washington, DC: Heritage Foundation. McDonald's Corporation (2007) 2007 Annual report. Oak Brook, IL, McDonald's Corporation. McDonnell, J. (2003) International financial reporting standards and revenue recognition. New York: PricewaterhouseCoopers. Appendix A: Group Profit and Loss Account of Domino's as of 31 December 2006 [Source: Domino's, 2007, p. 28] Appendix B: Group Balance Sheet 2006 [Source: Domino's, 2007, p. 30] Appendix C: Turnover and Segmental Analysis 2006 [Source: Domino's, 2007, p. 36] Read More