The Domino’s pizza operator, a hot stock and favourite of large investors is cooling off as growth rate slows down and higher costs squeeze margins

Every now and then, there comes a story which catches everyone's fancy, creates frenzy like there is no tomorrow. Jubilant Foodworks (JFL) is one such story. For the uninitiated (hardly anybody), the company runs a highly successful pizza store chain by the brand name, Domino’s. It has a particular focus on the home delivery business and has set new benchmarks there.
 

Rising disposable income, favourable demography and changing palates have helped create a story, which could not have been missed by any investor in the Indian markets, domestic or foreign. Fantastic growth, great profitability and a bull market have taken Jubilant Foodworks to dizzying heights in terms of valuations and expectations. Often when there is a consensus among market players, especially at high valuation levels, disappointment cannot be far behind. How could JFL possibly disappoint? Well, there are some cracks in the JFL story which is worth paying attention to.

Exorbitant Rent?
 

Domino’s specialises in home delivery and thus its stores are small. While checking out all the stores is not possible, size of stores in a city like Mumbai seems of the order of 700-800 sq. ft. (but is still an approximation). JFL has indicated that the stores in the Tier II/III towns are larger and average size would probably be more in the range of 1,200 sq. ft. The company paid a rent of about Rs116 crore for FY13. Even if we take the average number of stores calculated above, average size of 1,300 sq. ft., then some arithmetic would lead us to conclude that the average rent paid per sq. ft per month is around Rs143! This is when half the stores are NOT in Tier I cities and this number has been increasing over years even as incrementally more stores are coming up in the Tier III ones.           
 

Surprisingly High Rental Cost
    

The assumption of the per-store area could be off the mark. So let us look at the stores and rent paid. While the average number of operational stores has increased from FY09 to FY13 by 147% (about 25% pa), rent has gone up by 334% (44% pa).
 

Galloping Store Rent
 

Exorbitant Cost of Interiors?
 

The interiors of a Domino’s Pizza stores are modest. Looking at the gross block, let us focus only on the “Leasehold Improvements” bit. FY13 has an entry of Rs192 crore. Assuming 20% of it has gone into commissaries or what company calls “factories”, we would still be left with around Rs150 crore. Again if we take 1,300 sq ft as the average size, it would work out to around Rs1,900-2,000 per sq ft of expenses. And furniture/fixtures and plant/machinery are not included here.

Let’s compare this with Shopper’s Stop. As of March FY13, Shoppers’ Stop had 3.4 mn sq ft of retail space and the gross block was Rs683 crore. So it seems like they spend around Rs2,000 per sq ft in terms of capex. And out of that “Leasehold Improvements” account for around 35% (Rs 700 per sq ft) of that, less than 40% of Domino’s.

The nature of operations within the premises of these two retail businesses is different and thus obviously would require different store interior setups. Just thought the cost difference in setting up the two stores was interesting enough to share.

The other thing with this “Leasehold Improvement” part is that, everything spent under this head is treated as revenue expenditure in the Income Tax books. Thus a deferred tax liability is created in accounting books and obviously is cash savings to that extent.

As per FY13 Annual Report, deferred tax liability created on this account was Rs15.57 crore. Assuming tax rate of 33%, it would roughly mean that reported PBT for Income Tax purposes would be lesser by about Rs47 crore. PBT was 197.4 crore. for FY13. This change in treatment happened first in FY12 (Rs10 crore Deferred Tax Liability) and was followed up in FY13. For an asset which is going to last a few years, to be “depreciated” in one year is little odd, but as per Annual Report they have relied on expert advice.

Profitability
 

For FY13, EBITDA for JFL was about Rs250 crore. Taking the average number of stores operational for the year at 521, EBITDA per store comes out to about Rs48.5 lakh. From 9 months FY14, similar calculation would lead to an approximate annualised EBITDA per store of Rs42-43 lakh per store. Not a surprising result given that EBITDA in FY14 has grown slower than the number of stores. I happened to come across the latest presentation by Domino’s US, where they have stated that, their US per-store EBITDA is near the top end of historic range around $75,000 annually. The same number for JFL for FY13 would be $80,000+ and for FY14 closer to $70,000 or Rs44 lakh per store.

US pizza market is likely to be a lot more competitive than India and also has 1/4th the population. But then per capita GDP is also something like 30x of India. So while there may not be a strict apple-to-apple comparison between these two EBITDA per-store numbers, it’s a data point, which catches the eye.
 

And let us not forget JFL pays “Franchisee Fee” for using the “Domino’s” brand name. That number was Rs47.6 crore for FY13. Domino’s US, one would assume, will have no such expense.

So what we have here is that a retail consumption story in developing economy having same or higher $ profitability than in a developed, consumption crazy nation. And this is after a big “Franchisee Fee” being borne in the developing nation.

Realisation and Volumes
 

Domino’s had 465 stores as of March 2012 and ended March 2013 at 576 stores, so roughly 521 stores were operational for the year FY13 on an average. If we go by the number of pizzas that were sold, as per the information in the Annual Report (66 lac per month), it roughly comes out to a number of 417 pizzas sold per store per day.

I think it would be reasonable to assume that the mature stores in cities like Mumbai, Bangalore and Delhi etc. would be clocking closer to 500-550 pizzas per day on an average, with stores in smaller towns clocking lower volumes. The stores are open from 11am to 11pm. Out of these 12 hours, some early morning and late afternoon time would be really slow, so most business would be kind of concentrated in around 10 hours.

That roughly means around 50 pizzas in an hour. The company has indicated that roughly 50% of the volumes are towards home delivery and the remaining are dine-in orders. Going by that it looks like a pizza is delivered every 2-3 minutes. So a bike moves out of the store every 2-3 minutes. If there are 2 pizzas per order, it would be 5 minutes. It is surely a very frenetic place! And store volumes are expected to keep growing!

While we are on the number of pizzas sold, have a look at the following table.
 

Realisation Per Pizza     
    

This indicates that the realisation per pizza seems to be cooling off, even as prices have been increased to counter raw material inflation. It could also partly be a result of customers “downtrading” to lower value/size pizzas. But the menu card as of now has only one kind of pizza below this average price of Rs135 and two others which kind of roughly match it. Or maybe I have erred in interpreting the data.

The Cheesy Bit
 

The other small interesting part is the consumption of cheese, the largest part of raw material consumption.

Cheese Cost is Surprisingly Stable  
                  

Raw material inflation has been one of the big cost drivers for the company. If one analyses the cost of cheese for FY09-11, it looks like there was hardly any inflation. Quantitative information on cheese consumption is not available from FY12. So we don’t know the exact cost trend for the past two years. But broadly, the value of cheese consumed has grown in sync with the growth in the number of pizzas sold. So would that mean, inflation in cheese is very minimal?

Promoters are Bailing Out?
 

Meanwhile on the shareholding front, since March 2012, promoter shareholding has gone down by about 43 lac shares. Looking at the price during this time, the sell value should be Rs450-500 crore, if not more. Promoter shareholding has been coming down consistently from 62.07% in March 2010 to 49.9% in December 2013. December 2013 pattern shows about 20 lakh shares in the “pledged” category.

Given the sluggish financial performance in recent quarters, the JFL stock price has cooled off from its highs. But the valuation still remains “stiff” at 50+ P/E FY14. The potential store count for Domino’s Pizza in India is put at 1,200. The number of stores is nearing 700 and clearly the growth in store numbers will taper off at this huge base. Turnover growth will likely follow the same path, even though company will try and counter that with new products and schemes.

But there are other consumption stocks which are also richly valued in the face of slowdown. Investors obviously are betting that the longer-term picture is much better than what is painted by the present slowdown. Enjoy while it lasts.