Domino’s Pizza (LSE: DOM) is proof that you don’t need a unique product or service to generate massive returns. Competition has hotted up in the last few years as online order aggregation companies like UberEats, Deliveroo and Just Eat (LSE: JE.) have created a marketplace where takeaways compete.
These marketplaces, usually apps, help consumers find the top-rated takeaways in their area and reward quality, low pricing or a combination of the two. Domino’s is not listed on these apps, preferring to sell its pizza directly to customers.
But can a pizza delivery chain still deliver outsized returns on capital for investors in a world where we have mind-boggling choice at our fingertips? In my opinion, recent results point to a tougher future for it.
UK sales growth slowed considerably in the last year. Like-for-like sales increased only 2.4%, a far cry from last year’s 13% increase and the entire group grew sales faster due to the opening of more branches and stronger overseas LFL growth.
Undeterred by slowing growth, the company will shortly open its 1,000th British unit and still has its sights firmly set on growing the portfolio to 1,600. Online sales generated 75% of orders, indicating a heavy cross section of competition between Domino’s and other online ordering websites already. I believe this could be the cause of the sales slowdown in the UK.
A large Margherita sets you back £14.99. I believe Domino’s rich prices could make it an easy target for other pizza delivery businesses. I’ve switched to a cheaper local alternative and I’m sure many others have too.
To be clear, I’m not forecasting doom for Domino’s, but a potential slowdown in LFL sales and a lower return on capital. It might still be a fantastic business with enviable brand strength and product quality thus far keeping the orders flowing in. But the shares are priced as if growth will continue. The P/E is currently 34. To me, that’s a little ambitious despite a strong balance sheet and cashflows.
Network effects – the Domino’s fall
If you’re looking to profit from the rise in online food ordering, I’d take a look at Just Eat. It is the largest takeaway aggregator in the UK and has enviable network effects in play that could lead to massive growth.
As more people order via its platform, it becomes a more attractive marketplace for takeaway restaurants to sell into. These new restaurants increase choice and competition, therefore improving the service as a whole and attracting more customers. This ‘network’ of consumers and sellers is currently growing stronger in a virtuous cycle.
Because Just Eat is the biggest network in the UK, I believe its network effects could crown it the most dominant. Just Eat’s biggest competitor? It’s not Domino’s or any of the other online aggregators – but the telephone.
Roughly half of all UK takeaway orders are still made by phone. As new generations earn enough pocket money to order pizzas, I’d expect this ratio to drastically fall until almost all orders are completed online. And I’d expect the largest network in the country, Just Eat, to be the natural benefactor of this channel shift.
The shares are currently priced at 67 times earnings, but with LFL revenue rocketing 40%, the shares could easily outgrow this valuation.
If these two growth shares are too risky for you, or if you’re not a fan of the takeaway sector, maybe you’d be more suited to our top growth stock. This undeniably suave chain has been charming the cash from the wallets of both Brits and international investors for years now. Our top analyst believes this expansion story could quadruple in value by 2025 if everything goes without a hitch. Click here to download the free report.
Zach Coffell has no position in any shares mentioned. The Motley Fool UK has recommended Domino’s Pizza and Just Eat. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.