Dominos Pizzas Profitability - Essay Example

Domino’s Pizza’s Profitability I. Introduction - Include: Framework/Context/Purpose/Aim The purpose of this report is to analyze Domino’s Pizza’s profitability, as well as suitability of the company as a viable business venture. A major supermarket company is considering moving to the fast-food industry. In line with this, Domino’s Pizza is seen as a major player in the industry. In order to determine if investing in the company would be a profitable venture, analysis of Domino’s Pizza’s financial reports is crucial. In order to analyze the viability of the venture, key project feasibility studies has been used, which includes market study, technical study and financial study of the business. This is to ensure that even when the venture is proven to be profitable in the short-run, the success of it in the long-run for the supermarket company is also sustainable. II. Methodology In order to see if venturing into a pizza company such as Domino’s is profitable, the perspective taken is from the point of view of a business analyst. By looking at the data from the data this way, instead of looking at it from the common investor’s point of view, the perspective is broadened to include marketing strategy and market potential where the industry the company is currently a player. We look at the Group’s Profit and Loss statement to derive its profitability, then looking at the balance sheet of the company given the two periods to determine changes and where those changes come from and how they happen, then looking at the key financial ratios to determine the company’s profitability, efficiency, way of financing and increase in shareholders’ value—all these done by benchmarking the derived figures against those of a major competitor’s. The major competitor that is used to benchmark the results is the global giant’s affiliate company in UK, Pizza Hut UK. The strength of the global brand of Pizza Hut provides a reason to make it a suitable competitor for Domino’s Pizza. Although benchmarking is done by comparing results against those of a global and major competitor, it does not give the whole picture for the analysis. However, due to lack of resources, it is not cost effective to come up with a peer industry average where the results of the analysis for the Group can be more accurately gauged. With the lack of resources to come up with a peer industry average where Domino’s Pizza company’s analysis can be measured against, the Pizza Hut UK’s strength as a competitor can be used as an alternative. But to broaden our perspective, we do not rest on the financial analysis of the company, rather we look at the overall market. By knowing the trends of the market, the segments and the necessary forces that Domino’s Pizza considers before it crafts its strategy to ensure success, we too can see if the health of the company is just for the short-term, or rather is more sustainable in the long run. III. Revision of Data The UK GAAP uses a different way of presenting its financial statement, which requires revision of the data in order to derive certain ratios and analyze the real standing of the company. Domino’s Pizza’s annual report provides a handful of information that is relevant to the analysis. The notes provide some detailed explanation for some of the entries in the financial statement. However, the breakdown of the items is not enough that made us consult another useful report, which are its financial reports in the FAME database. The data from the annual report and financial reports are arranged and fit into a balance sheet format that details the items of the current assets, fixed assets, current liabilities, long-term liabilities and shareholders’ equity in order to derive the ratios. The revision does not require a major adjustment in terms of the data, which can distort the analysis. Instead, it only requires certain items to be classified in certain groups in order to derive the ratios. The revision is only concerned on how the data is presented in order to breakdown the financial statement, thus making it more suitable for the analysis. IV. Findings – Analysis Findings on the Group’s Profit and Loss Statement For every pound in sales, Domino’s Pizza earned £.39 in gross profits, £.14 in operating profits and £.11 in net profits in the year 2006. Last year, for every £1 in sales, the company earned £.40 in gross profits, but got lower in operating profits which is equal to £.13 and £.10 in net profits. In order to improve profitability, Domino’s Pizza lowered down its profit margin to spread its overhead, thus, increasing its operating profits and net profits in effect. These figures for the company were high compared to Pizza Hut’s operating profit margin of 2% and net profit margin of 0.49%. Findings on the Group’s Balance Sheet Domino’s Pizza invested in £4.5 million in its assets. This investment was financed by an increase in short-term liabilities amounting to £8.865 million. While the liabilities were big enough to cover just the £4.5 million increase in assets, some of the amount went to: retirement of long-term liabilities amounting to £905,000; shares buyback, as stated in note 24 in the company’s 2006 annual report, mainly through its Profit and Loss account which amounted to £10.5 million, and the excess of the cash raised from the liabilities were used for the rest; and dividend declaration which was equal to £4.23 million. The company is less conservative in terms of its capital structure comprised of 79% debt and 21% equity to finance its assets. Although these figures were higher, they did not vary too much from its competitor Pizza Hut, which finance its assets with 73% debt and 27% equity. Domino’s Pizza has positive cash flows from its assets, and was able to distribute £10.7 million worth of free cash flows to its investors—its creditors and its stakeholders. About 74.32% of the total increase in assets went to current assets, which was up by £3.352 million from £20.992 million in 2005 to £24.344 million in 2006. Findings regarding the Group’s key financial ratios The Group’s current ratio decreased from last year’s 1.53 to this year’s 1.08; the change was attributable to the large increase in its liabilities. Given the figure, Domino’s Pizza’s current ratio was still higher than its competitor Pizza Hut which current ratio was 0.21. In order to assess the firm’s ability to pay its current obligations, acid-test ratio was derived and provided a stricter measure. The Group’s acid-test ratio remained strong at 0.996, but way smaller than last year’s 1.37; again the decrease was attributable to the increase in liabilities. Pizza Hut’s acid-test ratio was 0.18, which put it into a less favorable liquidity position than Domino’s Pizza. With the assumption that all sales were on credit as notes lack in depth discussion of the company’s collection policies, the Group’s average collection period improved from 57.75 days in the past year to 47.06 days in 2006. However, in comparison to Pizza Hut, Domino’s collection period was way longer; Pizza Hut had a collection period of 11.45 days in 2006. This raised a question whether Domino’s Pizza just chose profitability that it allowed a long collection period with its customers; but this also signified inefficiency in collection given the huge difference between the company and its competitor Pizza Hut. In connection with this, Domino’s low accounts receivable turnover of 7.756 times a year fell way behind its competitor which had 31.88 times a year. This figure only followed the previous discussion about the Group’s long collection days; despite the fact that Domino’s had improved from the last year’s 6.32 times a year accounts receivable turnover, it could still be considered a major shortcoming. This lag in collection could also be associated with the credit terms the company gave its franchisees; mostly its debtors were its franchisees as discussed in note 16 in its Notes for Financial Statements section of its annual report. Only that the huge difference with its competitor Pizza Hut may not only indicate and attribute it to differences in policy, but the difference did not quite justify everything in terms of its collections. In terms of profitability, the Group has been doing well with 34% in operating income ROI (operating income divided by total assets) this year, as compared to 28.5% during the previous year. These figures were relatively high compared to Pizza Hut’s 5% in 2006, and 18% in 2005. The operating profit margin of Domino’s Pizza improved from 12.7% in 2005 to 14% in 2006. The operating profit as compared to its competitor Pizza Hut with 2% was still higher. The rate of the increase in operating income was higher than the rate of increase in sales, which gave the company a higher operating profit margin. The Group maintained efficiency in utilizing its assets in generating sales, as apparent in its total assets turnover of 2.32 times, which improved from 2.25 during the previous year. However, the competitor fared better in utilizing its assets, with 2.55 times for its total assets turnover, which made it seem more efficient in generating sales in terms of its assets. While Domino’s Pizza fared less than its competitor in utilizing its assets to generate sales, it was using its fixed assets better. Its fixed assets comprised of its tangible assets, as well as intangible assets generated more sales per assets, compared to its competitors. The group has a fixed assets turnover of 5.75 times, improved from the previous year’s 5.31, and higher than Pizza Hut’s 2.91. Domino’s Pizza utilized a capital structure of 79% debt and 21% equity in 2006, it became less conservative from its previous year’s 67% debt and 33% equity capital structure. The change was attributable to the increase in liabilities, as previously discussed in the findings in the balance sheet. While these figures did not vary much from Pizza Hut, with a capital structure comprised of 73% debt and 27% equity in 2006. To analyze how these figures could affect the profitability of the company, we computed the times-interest earned ratio, or interest coverage in terms of net income. Domino’s Pizza had a times-interest earned ratio of 27.2, down from last year’s 29. It was still good to know that its income was 27.2 times the interest that it paid in 2006. These figures, as compared with Pizza Hut’s 5.26 times, showed that the Group was more capable of paying its interest payments with the income that it earned. As one of the most important measures in our analysis, the return on equity or ROE was derived in order to look at the returns that the company provided to its investors. Domino’s Pizza did very well in increasing the value of the company with its ROE of 122.9 % in 2006; the Group had been able to increase value of the shareholders’ wealth more than a hundred percent. ROE dramatically improved from 68.8% in 2005, and way much higher with Pizza Hut’s 4.6% in 2006. Marketing strategy The success of Domino’s Pizza could be attributed to its aggressive marketing efforts. As apparent in the company’s high fixed assets turnover, and high ROE, the company was able to create value by utilizing the Domino’s Pizza brand over the internet. The Group currently plays in the £1.3 billion home delivered food segment of UK’s £29 billion eating out market. In order to look at the Group’s success, we need to look at the current strategy the company employs in order to achieve its goal. The company positions itself in the mind of its consumers as the top-of-mind for pizza home delivery. Domino’s Pizza has been able to utilize this insight as very powerful, which helps it surge and thrive even in the UK’s down economy during the past years. The home delivery segment of the market, although meager provides a healthy source of income for the company as it is grounded on a need. As the Stephen Hemsley, Chief Executive has put it in an interview with BBC in 2002, even in a down economy home delivery is primary choice for people who are not used to cooking food themselves. This need proves to be beneficial to the company, that it uses it to position the company in the mind of its consumers. While the company positions itself as a home delivery pizza company in the UK, it does not abandon its system sales or the operations of its chains of stores it the country. By opening more stores in the country to support its delivery system and focus on minimizing ‘out-the-door’ or the time from when the order is placed up to the time it is delivered. With its effort to utilize different ways to build relationship with consumers, the company leverages on the popularity of the internet and focuses on its e-commerce operations, which proves to be the fastest-growing segment in its operations. To build Domino’s Pizza brand is a major strategy the company uses in order to improve operations. The Group recognizes that in order to sustain high level of sales, the company has to build long-term relationships with its consumers through branding. While maintaining a close relationship with them through the company’s marketing communication messages, satisfaction levels on product performance or in the company’s case, the taste and quality of its pizzas, has been the focus of the company to surpass consumers’ satisfaction. The repeat purchase of its products, attributable to its satisfactory quality and superb performance of the delivery service, has created value for the company by means of increasing brand equity for the company. The strength of the Domino’s Pizza brand can be considered one of the major forces that drive the large sales among the company. V. Conclusion Indeed, 2006 has been a breakthrough year for Domino’s Pizza, as the Chairman of the Board coins it. The company, in comparison to the giant’s affiliate company Pizza Hut UK, fares far better in many areas. The company proves to be a profitable venture, with an ROE of 123% which is higher than the previous year’s 69%. This success is not a windfall success to the company as a result of environmental favorability; instead the company proves that it can maintain profitability by adopting a consumer-centric philosophy and focusing more on its consumers as a strategic decision for its long-term success of its operations. Apparent in its marketing strategy, Domino’s Pizza realizes that it cannot rely on push-product efforts and advertising to just increase its sales; thus, it decides to strategically manage its brand to ensure its success. By building its brand by focusing on the consumers well and creating relationships that last, the company is able to maintain high levels of sales through repeat purchases. The company adopts an integrated approach to managing its marketing communications, in order to strategically manage its brand. By positioning itself as top-of-mind home delivery pizza company, it uses the most powerful medium for now—the internet, and ventures into the e-commerce to profit from the opportunity. This integrated approach ensures long-term relationships with consumers which results in satisfaction that guarantees repeat purchases, thus making the success more secured as it was not mainly attributed to happenstance and environmental favorability. In terms of profitability, the Group fares better than its competitor Pizza Hut. It is able to lower down its costs of operations that make its profit margins higher than its competitor. By integrating the strength of its brand with the store operations, both the intangible and tangible assets generated higher sales per pound in assets, this attests to the company’s efficiency. In handling its debt, the company has a high interest coverage ratio too, in terms of the income that it earns; which makes it seem more capable of managing its financing through its debts. Overall, Domino’s Pizza company is a good venture. While the company maintains strategic approach to managing its operations, the success of the company is viewed from the long-term perspective of management by building its brand and focusing well on its consumers. The strength of the systems of the company in place to support its marketing strategy contributes to its success too. While the home delivery segment of the market is the main segment where the company competes, the segment assures growth. The positioning of the company is also sustainable in the long run which makes its success more stable and ensured. VI. Recommendation Although Domino’s Pizza has fared well in 2006, a few weak spots have been found where the company can improve on. This includes improvement in utilizing its total assets to generate sales, in comparison with the global giant affiliate company Pizza Hut UK, as well as improvement in its collection policies to ensure liquidity. While the company increased its liabilities in order to finance growth, as well as to declare dividends, the company has to ensure better liquidity as it can no longer increase its debt structure without sacrificing its credit ratings. The debt-equity structure of the company is currently aggressive, with its high debt ratio compared to equity. Although most of the debtors of the company are mostly franchisees, it is not enough reason to justify a major lag in collection as compared to its competitor. While the company prides itself of its low bad debts and credit scoring policy to determine qualified franchisees, it is still important to improve collection efforts to ensure liquidity. As previously stated, the company cannot rely on increasing its liabilities without sacrificing its credit ratings, so to ensure that the company has enough cash in order to maintain operations should be one of the areas to improve on. Domino’s Pizza’s increase in assets allocated a major portion to its current assets. The company has to ensure that the returns from sales generated by its total assets are good enough to ensure efficiency. Its fixed assets turnover ratio is high, but if the large portion of the increase goes to the current assets, it is also important to ensure that such increase will generate huge return in order to create more value for its investors. VII. Appendix REVISED BALANCE SHEET FOR DOMINO’S PIZZA DOMINO'S PIZZA UK AND IRL 12/31/2006 12/31/2005 CHANGE ASSETS Cash 10262 25.11% 5885 16.18% 4377 97.05% Accounts receivable 12244 29.96% 12921 35.53% -677 -15.01% Inventories 1838 4.50% 2186 6.01% -348 -7.72% Other current assets 0 0.00% 0 0.00% 0 0.00% Total current assets 24344 59.56% 20992 57.73% 3352 74.32% Tangible assets 13780 33.72% 13593 37.38% 187 4.15% Intangible assets 2159 5.28% 1326 3.65% 833 18.47% Investment in joint ventures 589 1.44% 451 1.24% 138 3.06% Total fixed assets 16528 40.44% 15370 42.27% 1158 25.68% Other assets 0 0.00% 0 0.00% 0 0.00% TOTAL ASSETS 40872 100.00% 36362 100.00% 4510 100.00% LIABILITY AND SHAREHOLDERS' EQUITY Liabilities Other loans 822 2.01% 0 0.00% 822 18.23% Bank overdraft 6000 14.68% 923 2.54% 5077 112.57% Finance lease creditors 13 0.03% 18 0.05% -5 -0.11% Trade creditors 4059 9.93% 3930 10.81% 129 2.86% Corporation tax 2339 5.72% 2194 6.03% 145 3.22% Other taxes and social security costs 1415 3.46% 1230 3.38% 185 4.10% Other creditors 1808 4.42% 1388 3.82% 420 9.31% Accruals and deferred income 6151 15.05% 4059 11.16% 2092 46.39% Total current liabilities note 16 f/s 22607 55.31% 13742 37.79% 8865 196.56% Long-term debt 9009 22.04% 9085 24.98% -76 -1.69% Bank loans 7500 Finance lease creditors 32 Other loans 1477 Provision for liabilities 652 1.60% 1447 3.98% -795 -17.63% Minority interest 48 0.12% 82 0.23% -34 -0.75% Total long-term liabilities note 17 f/s 9709 23.75% 10614 29.19% -905 -20.07% Common Equity Called up share capital 2574 6.30% 2645 7.27% -71 -1.57% Share premium account 4765 11.66% 4677 12.86% 88 1.95% Capital redemption reserve 261 0.64% 171 0.47% 90 2.00% Treasury shares held by Employee Benefit Trust -4216 -10.32% -7500 -20.63% 3284 72.82% Profit and Loss account 5172 12.65% 12013 33.04% -6841 -151.69% Total common equity 8556 20.93% 12006 33.02% -3450 -76.50% TOTAL LIABILITIES AND SHE 40872 100.00% 36362 100.00% 4510 100.00% RECONCILIATION OF SHs' FUNDS At 1 January 2006 12006 14847 Proceeds from share issue 403 472 Share buybacks -10457 -8222 Treasury shares held by EBT 0 -1140 Profit for the year 10515 8255 Exchange difference on translation of net assets of subsidiary undertaking -21 963 Share option and LTIP charge 344 -3169 Dividends -4234 0 At 31 December 2006 8556 12006 REVISED BALANCE SHEET FOR PIZZA HUT UK PIZZA HUT UK 12/31/2006 12/31/2005 CHANGE ASSETS Cash 4008 2.73% 0 0.00% 4008 -89.93% Accounts receivable 11759 8.01% 10658 7.04% 1101 -24.70% Inventories 2088 1.42% 2153 1.42% -65 1.46% Other current assets 0 0.00% 0 0.00% 0 0.00% Total current assets 17855 12.16% 12811 8.47% 5044 -113.17% Tangible assets 124138 84.53% 136046 89.91% -11908 267.18% Intangible assets 2410 1.64% 2456 1.62% -46 1.03% Investment in joint ventures 2453 1.67% 0 0.00% 2453 -55.04% Total fixed assets 129001 87.84% 138502 91.53% -9501 213.17% Other assets 0 0.00% 0 0.00% 0 0.00% TOTAL ASSETS 146856 100.00% 151313 100.00% -4457 100.00% LIABILITY AND SHAREHOLDERS' EQUITY Liabilities Other loans 38325 26.10% 14295 9.45% 24030 -539.15% Bank overdraft 0 0.00% 9852 6.51% -9852 221.05% Finance lease creditors 0 0.00% 0 0.00% 0 0.00% Trade creditors 13936 9.49% 14256 9.42% -320 7.18% Corporation tax 2139 1.46% 4254 2.81% -2115 47.45% Other taxes and social security costs 9608 6.54% 9799 6.48% -191 4.29% Other creditors 2723 1.85% 3163 2.09% -440 9.87% Accruals and deferred income 19302 13.14% 17586 11.62% 1716 -38.50% Total current liabilities 86033 58.58% 73205 48.38% 12828 -287.82% Long-term debt 11884 8.09% 0 0.00% 11884 -266.64% Bank loans Finance lease creditors Other loans Provision for liabilities 9646 6.57% 9465 6.26% 181 -4.06% Minority interest 0 0.00% 0 0.00% 0 0.00% Total long-term liabilities 21530 14.66% 9465 6.26% 12065 -270.70% Common Equity Called up share capital 805 0.55% 805 0.53% 0 0.00% Share premium account 0 0.00% 0 0.00% 0 0.00% Capital redemption reserve 0 0.00% 0 0.00% 0 0.00% Treasury shares held by Employee Benefit Trust 0 0.00% 0 0.00% 0 0.00% Profit and Loss account 38488 26.21% 67838 44.83% -29350 658.51% Total common equity 39293 26.76% 68643 45.36% -29350 658.51% TOTAL LIABILITIES AND SHE 146856 100.00% 151313 100.00% -4457 100.00% FINDINGS IN THE INCOME STATEMENT OF DOMINO’S PIZZA 12/31/2006 12/31/2005 a Gross profit margin   gross profit 37154 39.12% 32882 40.27%             sales 94965   81660   b Operating profit margin operating profit 13789 14.52% 10378 12.71% sales 94965 81660 c Net profit margin net profit 10515 11.07% 8255 10.11% sales 94965 81660 FINDINGS IN THE INCOME STATEMENT OF PIZZA HUT UK 12/31/2006 12/31/2005 a Gross profit margin   gross profit                     sales 374904   394963   b Operating profit margin operating profit 7502 2.00% 27789 7.04% sales 374904 394963 c Net profit margin net profit 1821 0.49% 16607 4.20% sales 374904 394963 KEY FINANCIAL RATIOS FOR DOMINO’S PIZZA 12/31/2006 12/31/2005 1. Firm liquidity current ratio current assets 24344 1.07683461 20992 1.5275797 current liabilities 22607 13742 acid-test ratio current assets-inventories 22506 0.99553236 18806 1.3685053 current liabilities 22607 13742 average collection period accounts receivable 12244 47.0600748 12921 57.753674 daily credit sales 260.18 223.73 average receivable turnover credit sales 94965 7.75604378 81660 6.3199443 accounts receivable 12244 12921 inventory turnover   cost of goods sold   57811 31.45 48778 22.31           inventory   1838   2186   2. Operating profitability operating income ROI operating income 13789 0.33737033 10378 0.2854078 total assets 40872 36362 operating profit margin operating income 13789 0.14520086 10378 0.1270879 sales 94965 81660 total assets turnover sales 94965 2.32347328 81660 2.2457511 total assets 40872 36362 accounts receivable turnover credit sales 94965 7.75604378 81660 6.3199443 accounts receivable 12244 12921 inventory turnover   cost of goods sold   57811 31.45321 48778 22.313815           inventory   1838   2186   fixed assets turnover sales 94965 5.74570426 81660 5.3129473 net fixed assets 16528 15370 3. Financing decisions debt ratio total debt 32316 0.79066353 24356 0.6698201 total assets 40872 36362 equity ratio total SHE 8556 0.20933647 12006 0.3301799 total assets 40872 36362 times interest earned operating income 13789 27.1972387 10378 28.988827 interest expense 507 358 4. Return on equity return on equity net income 10515 1.22896213 8255 0.6875729 common equity 8556 12006 KEY FINANCIAL RATIOS FOR PIZZA HUT UK 12/31/2006 12/31/2005 1. Firm liquidity current ratio current assets 17855 0.2075366 12811 0.1750017 current liabilities 86033 73205 acid-test ratio current assets-inventories 15767 0.1832669 10658 0.1455911 current liabilities 86033 73205 average collection period accounts receivable 11759 11.448357 10658 9.8494543 daily credit sales 1027.13 1082.09 average receivable turnover credit sales 374904 31.882303 394963 37.057891 accounts receivable 11759 10658 inventory turnover   cost of goods sold                     inventory   2088   2153   2. Operating profitability operating income ROI operating income 7502 0.0510841 27789 0.1836524 total assets 146856 151313 operating profit margin operating income 7502 0.0200105 27789 0.0703585 sales 374904 394963 total assets turnover sales 374904 2.5528681 394963 2.6102384 total assets 146856 151313 accounts receivable turnover credit sales 374904 31.882303 394963 37.057891 accounts receivable 11759 10658 inventory turnover   cost of goods sold                     inventory   2088   2153   fixed assets turnover sales 374904 2.90621 394963 2.8516772 net fixed assets 129001 138502 3. Financing decisions debt ratio total debt 107563 0.7324386 82670 0.5463509 total assets 146856 151313 equity ratio total SHE 39293 0.2675614 68643 0.4536491 total assets 146856 151313 times interest earned operating income 7502 5.2608696 27789 35.856774 interest expense 1426 775 4. Return on equity return on equity net income 1821 0.0463441 16607 0.2419329 common equity 39293 68643 VIII. 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