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People Think Domino’s Makes Money by Selling Pizza, but 60% of Its Revenue Comes From Something Else Entirely

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friends eat pizza in a home setting

With over 20,000 locations worldwide, Domino’s Pizza (NYSE: DPZ) is Earth’s biggest pizza company. So how much money do you think it makes from selling pizza to hungry customers? $1 billion? $5 billion? $10 billion?

What if I told you that Domino’s has generated revenue of less than $400 million in pizza sales over the last 12 months? This number might sound absurdly low, but it’s accurate. Most of the company’s revenue actually comes from something other than selling pizza, and many investors don’t realize how Domino’s business model actually works.

Domino’s Pizza, the supply chain company?

According to the company’s filings, Domino’s has generated $2.7 billion in trailing-12-month supply chain revenue. This is a whopping 60% of its top line for this period.

As it turns out, Domino’s owns only 1% of the company’s 20,000 locations. Revenue from selling pizza directly to customers is consequently low.

The other 99% of Domino’s locations are owned by franchisees — independent third parties. These franchisees have the option of sourcing their own supplies, but Domino’s has shrewdly found a way to get them to choose its supply chain instead.

Domino’s has a fleet of over 1,000 tractors and trailers delivering food, supplies, and equipment to its company-owned and franchised stores. On the food front, the company has dozens of facilities producing its pizza dough.

Domino’s does make a profit providing these supplies, but to incentivize its franchisees to buy in, it shares supply chain profits with them — generally about 50% of the pre-tax profits, according to management.

Thanks to this profit-sharing system, Domino’s sees high adoption among U.S. and Canadian stores. Supplying more than 7,200 locations, the company enjoys efficiencies of scale. Moreover, Domino’s can ensure quality and consistency with its food since it’s all being sourced from the same place.

Why go to so much trouble?

It can be hard to develop any sort of competitive advantage in the restaurant industry, but some chains have found creative ways to do so. McDonald’s, for example, has built a multibillion-dollar real estate empire, charging rent to its franchisees.

Other pizza restaurants might be able to compete on taste, but with its scale, Domino’s competes very well on price. Moreover, if an operator is looking to franchise a pizza concept, the complete package Domino’s can offer is hard to beat.

This is huge for investors. The supply chain business might be low-margin for Domino’s — its supply chain gross margin is only 10% year to date — but it enables the company to attract and retain a high number of franchisees.

And that leads into the exciting part: Franchise fees and royalties are almost pure profit for Domino’s.

Franchisees renewed their contracts 99% of the time in 2022 — a stellar retention rate. This suggests the company is offering a lucrative opportunity to these operators, and the company hopes this will allow it to open more than 1,100 new franchised locations annually through 2028.

In short, Domino’s will see its high-margin fees from franchisees grow as it adds new units to the system. In turn, management expects operating income to deliver a minimum 8% compound annual growth rate through 2028.

Assuming this growth plays out, Domino’s operating profit should be 36% higher in 2028 compared with 2023. The company regularly repurchases shares and pays a growing dividend too. When factoring in all of this, investors could be looking at a 50% or greater total return over the next four years.

Such a performance would likely make Domino’s stock a market-beating investment over this time frame, which is great for shareholders. And it probably wouldn’t be possible without being a supply chain company first and pizza company second.

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Jon Quast has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Domino’s Pizza. The Motley Fool has a disclosure policy.

People Think Domino’s Makes Money by Selling Pizza, but 60% of Its Revenue Comes From Something Else Entirely was originally published by The Motley Fool

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