Domino's Pizza Group PLC

LSE:DOM

Earnings Call Transcript 2019-Q3

[David James Wild, CEO & Executive Director]

Good morning, everybody. Thank you very much for joining our call. As Jordan said, I'm with David Bauernfeind; and we also have Bethany Barnes, our Head of IR, on the call as well. We don't normally have a call at the Q3. But this year, we are announcing a change of strategy for our international business, and we therefore felt it would be appropriate to have the call. I'll make a few comments about both our U.K. and Ireland performance and our decision in international and will then be happy to take your questions. We had a solid performance in the U.K. and Ireland in the third quarter, with system sales up 3.9% on the back of a U.K. like-for-like performance of 3%. We opened 12 stores in Q3 in U.K./ROI, 9 in the U.K., 1 of which was corporate; and 3 in Ireland. And we also opened another one since the end of the quarter in the U.K. This adds to the 7 that we opened in H1. The U.K. and Ireland performance is influenced by a few different factors. As you'll know, the market backdrop is challenging and the consumer backdrop subdued. In particular, we've seen an increase in advertising by aggregators. And whilst we can't quantify precisely the impact, we do believe that this is a factor in our performance. Our national marketing campaigns were also a factor in the quarter. Campaign 4 was a less aggressive price point than the previous year, GBP 1 higher. And in campaign 5, we are not running a national campaign as we explained in the interims. A number of franchisees chose not to take part in the recommended promotion. And finally of course the weather. The weather in both late August and September wasn't helpful for pizza sales. The relationship with franchisees is very important to us. We are a franchise business, and the long-term sustainable growth of the system depends on the positive and collaborative relationship with our franchise partners. We recognize that this relationship is not where it needs to be and we're committing to improving it. As we talked at the interims, the situation is complex, and we do expect the resolution will take time. As we enter the final quarter of 2019, we can say that we will expect that this will not be resolved until 2020. I'll turn now to our international business. As we said at the interims, performance has been challenging in this segment for some time, although I am pleased to report that the financial results did stabilize in the third quarter. Over the past 6 weeks since the interims, we engaged a firm of external consultants to analyze each of the 4 markets. This comprehensive piece of work provided very helpful insight to the Board. And the conclusion of the Board meeting last week was that whilst these markets are attractive, we're not the best owners of the businesses, and we will now seek to exit these 4 markets in an orderly manner. They are different markets at different stages of development and different levels of profitability, so there's a high degree of complexity involved in managing this exit process. Iceland is a good, profitable business. Sweden is very immature but does represent a significant market opportunity in a country of 11 million people with no global pizza players. And Switzerland and Norway are both more challenging operationally largely because of the high labor costs. We're announcing this morning that we will be answering a formal process and we're therefore limited on what we can say further to the notes in the RNS. We're only just at the start of the process. Finally, a few words on board succession. You'll have seen in the separate RNS that we put out this morning, we're announcing the appointment of Elias Diaz as an NED. I think he'll be a great addition to the Board with his combination of experience in FMCG consumer brands and franchise businesses earlier in his career. The search for my successor continues, and the process for the new chair led by our recently appointed Senior Independent Director, Ian Bull, had commenced, and a search firm has been appointed. The Board intends that both processes are progressed as quickly as possible. With that, David, Bethany and I will be happy to take any questions. Jordan, we're ready for questions now.

[Operator]

[Operator Instructions] Our first question comes from Richard Stuber of Numis.

[Richard Paul Stuber, Analyst]

Could you please give us a little bit more color of -- on the complexity of exiting these markets? In particular, what factors need to be considered, such as the minority rights in these businesses, the involvement with DPI has anything on sort of endless leases? Just really giving it an idea about the complexity and the potentials of timing of these and whether you would expect them to be sold to 4 different buyers? Or would it be just more of a package? And the second question on the U.K. store openings. They've obviously accelerated this quarter. Anything behind that? Are the incentives which are being -- which is given to the franchisees, are they sort of largely unaltered from before? Any color on that would be great.

[David James Wild, CEO & Executive Director]

David will pick up the question on international. No, the -- there were no new incentives in the third quarter. It was -- it's always been the case that we open more stores in the second half than the first. And I think we're just building up the momentum now. So there were no additional incentives. David, do you want to pick up the international point?

[David Gregory Bauernfeind, CFO & Executive Director]

Yes. Thank you, Dave. Richard, yes, well, I think actually you've started to highlight the complexity, Richard. I think we're starting the journey today, having announced the exit of the 4 markets. And we're only just starting that journey today. So we have a very data-driven -- as David had said earlier, a very data-driven and externally advised process, which was run over the last 6 weeks and concluded as a result of that very recently. That we do want to exit these 4 markets but in an orderly manner. We have stabilized the performance in our international business and that puts us in a better position. We've got 4 markets that I think everybody on this call knows are at quite different stages, from very immature to mature, from pretty stable and good and profitable in the case of Iceland, to loss-making in case of the others, but with different levels of potential. And essentially, what we think is they're good markets, we're just simply not going to be the best operator in these markets. So we look to find somebody who'd be a better owner for these businesses to take them forward under the Domino's brand. So that's what we're looking to do. We're just starting that process today. And to give you an indication, in addition to the things that you mentioned, Richard, which are all factors in terms of stakeholders, et cetera, we haven't even appointed advisers. So we're literally starting that process today to kick it off. It will be complicated. They are 4 very different markets. And in terms of the nature of transaction or transactions that follow, it will depend on what happens. So I think it is important for all stakeholders to understand this is going to take some time. But we are starting the journey. We've made the decision. And we will do everything we can to maximize shareholder value, but also so that we can very quickly move on to focusing on the U.K. and Ireland business and rebuilding our relationship with franchisees, which is where our future is.

[Operator]

Our next question comes from Ross Broadfoot of Investec.

[Ross Broadfoot, Research Analyst]

Just a quick question. You've obviously given, in 2020, the date for a franchisee resolution I guess a couple of times now. What gives you the confidence to say that the issues will be sorted next year? And can you update on any steps taken at all?

[David James Wild, CEO & Executive Director]

I think we recognize the mutuality of interest between ourselves and our franchisees. And we're determined that we'll reach that win-win solution next year. I don't want to put a date on it. What we're saying this morning is it will be into next year before we reach that resolution, Ross.

[Operator]

[Operator Instructions] Our next question comes from Douglas Jack of Peel Hunt.

[Douglas Jack, Analyst]

Yes. I got 2 or 3 quick questions. What's the pipeline looking like for Q4, if that's okay in terms of the store openings? And then also the Brexit preparations you've put in place in terms of sort of storage and inventory. And any sort of impact coming through on food costs in relation to any of this? And lastly, the fourth question, sorry. Anything you're seeing in terms of consumer behavior? I think the last time you reported, you said that they were trading up in promotions, opting for more items per order, but perhaps not ordering quite as frequently. Is that the same trend that's going on at the moment?

[David James Wild, CEO & Executive Director]

Okay. I'll have a go and David can chip in. We've been very careful this year, Doug, at no stage to talk about store numbers other than what is open. So I'm going to plead the fifth on Q4. We're active on a number of sites, but there's always a degree of uncertainty, particularly at this time, about how many we're going to open. As far as Brexit's concerned, I think we said we've got about between 4 and 8 weeks additional inventory of ambient product and long-life frozen products. In the case of some frozen products, it's actually more than that in the country. So we're where we want to be in terms of having the inventory necessary to guarantee continuity of availability. So I think the team has done a good job on Brexit planning. The impact on food cost is uncertain. It could be that it's benign if the exchange rate strengthens in the way that it looks like it's going to. The cheese market's relatively stable at the moment. It looks like a good harvest. And obviously, the benefit of the higher -- better exchange rate against the euro means that food costs will be softer in the U.K. market. The one issue we've got on food cost is pork, where the Asian flu in China has caused global inflation in pork products. And that's something we've had to work very hard to mitigate. Not been as successful as we would like. But I think the outlook post-Brexit on food costs, if the exchange rate strengthens, looks okay. In terms of consumer behavior, I think it's very much more of the same. I'm going to ask Bethany just to make a comment in a second because she's got the numbers in front of her. But broadly, I think the trend is continuing.

[Bethany Barnes, Head of Investor Relations]

Yes. I don't think I'd add anything to that. I think it's very similar to that we spoke about at the interims.

[Douglas Jack, Analyst]

Okay. Can I just follow-up in terms of collection versus delivery? You've been targeting higher collections. Are you seeing any progress in terms of your marketing towards that and the numbers coming through?

[David James Wild, CEO & Executive Director]

We've certainly seen, as we've gone into the autumn, that the collection percentage has increased. And one of the messages we're giving to franchisees is that collection is, in many stores, a significant opportunity because the labor market is such that recruiting drivers is a challenge and the benefit of collection is that a lot of stores have marginal -- have labor available, particularly between 11 and 5, and collection therefore is a profitable increment to the sales. And it's also important in the context of new stores. So we are seeing some traction on that but still a long way to go.

[Operator]

Our next question comes from Wayne Brown of Liberum.

[Wayne Mervyn Brown, Research Analyst]

Just following on from Ross' question. I don't doubt that -- I think everyone would certainly agree that the interests of the plc and the shareholders and the system will perform much better when all those interests are aligned, so it is in everyone's interest to get that resolution sorted. And I'm not asking about when or putting a date to it, but what indications can you provide us today as to how those negotiations with the franchisees are progressing? What positive developments have occurred to give us some sort of indication that a resolution is possible next year and we might not have another 12 months in 2020 of franchisees not partaking in national campaigns and just the status quo lingering for quite some time? And then clearly with the aggregators' increasing marketing spend in a slightly uncertain environment, that things don't just progressively get modestly worse over 2020? So what developments have occurred? What's fundamentally going on with those negotiations that give you confidence that we can take the heat?

[David James Wild, CEO & Executive Director]

David, do you just want to make some comments on that?

[David Gregory Bauernfeind, CFO & Executive Director]

Sure. Yes. Wayne, look, I think as David has said, so we've indicated now as we get towards the end of the year that we -- this will certainly go into 2020 where we previously indicated that was likely. I think there's a number of things going on, and I certainly don't think it's helpful for anyone, for us, to give a running commentary of discussions that we have with franchisees. I think your point about the aggregators and also the broader macroeconomic environment is very relevant. So we're not in a benign environment here. We're in a very competitive environment with a weak economy in our home market. And I think it's in both our interest and our franchisees to make sure that we're focusing all of our attention in the U.K. and Ireland on the competition and presenting a fantastic offering to the consumer. If any franchisees were on this call, they would say exactly the same thing. So we are completely united in that. But as that can happen, sometimes there can be a bit of a misalignment or difficulties in the relationship, and that's what we have to fix. It's about relationship and it's also about -- a little bit about how we work together as the market matures and as the franchise matures. This is now a mature relationship, growth has slowed, and that's put a bit of pressure on the system and relationships. So I think I'm not going to give a running commentary, but I think that there's lots of good things happening, but this is still going to take quite a long time for us to be able to work through. There's not one single answer. And I think as we've indicated in the past, there are also different needs across our franchisee group. There isn't a single answer that satisfies all franchisees. They have different needs. And I think it's incumbent for us to recognize that different franchisees have different needs and to be able to tailor what we do to them.

[Operator]

Our next question comes from Julian Easthope of RBC.

[Julian Kenneth Easthope, MD & Analyst]

Just coming back to the aggregators, that's obviously been ramping up. I just wondered if you -- what your plans are to sort of try and counteract that, bearing in mind there the national campaigns are a little difficult at the moment. Second question, is it possible to elaborate a little bit what happened in Ireland? Because it obviously had a very weak -- a weaker-than-expected third quarter. And also discuss your AI rollout that you've been talking about. I just wonder, I know it's very early days, whether you've got any sort of -- give sort of comments about how well that's progressing.

[David James Wild, CEO & Executive Director]

I think the -- if I deal with the first point first, the aggregator question. The most -- the best way of dealing with aggregators is to give outstanding service. And we're absolutely committed to doing that and our franchisees are continuing to do that. So when we look at our satisfaction scores, delivery times, our franchisees are continuing to do an outstanding job for customers. And that's what we have to do because that's the foundation of our offer. Combining that with development of collection and looking at some underpotentialized areas of the day, like lunch and late night, is another way that we can grow sales in an environment where aggregators are stronger. I think the aggregators are falling out amongst themselves. There's clearly some issues with JUST EAT in the middle of a transaction. So we have to focus on what we can control, and it starts with having great service. On Ireland, Irish sales have always been volatile, and we had 2 very good quarters at the start of the year. Obviously, we were disappointed with the results in Q3, but it's not untypical in Ireland that things go up and down. There is a general mood of concern in Ireland around Brexit and what that's going to mean for the Irish consumer because the -- Ireland is very dependent on exports to the U.K. and the mood there does seem to be less positive than it was. But it's a relatively small part of the business. We've actually opened a number of stores in Ireland in the last 18 months, which we haven't done for the preceding 7 or 8 years. So I think the business in Ireland is in reasonable shape. On the AI point, the big area where we've used AI is in deployment of pay-per-click with Google. And we've been absolutely delighted with the results. And our -- in fact, our -- you may notice our online business in the quarter was up by 7.5%, which the biggest element of that is the impact that AI's having on our pay-per-click. So we're timing that much better, we're understanding which terms need to be used when, and we're getting great returns on that by using this AI tool.

[Operator]

Our next question comes from Heidi Richardson of UBS.

[Heidi Mercia Richardson, Associate Director and Equity Research Analyst]

Can I ask, as we're sort of approaching the end of the year, how you're seeing the cost inflation outlook for franchisees for 2020, I suppose most importantly on food and wages? And also linked to that, how are you thinking about the pricing trends in the business? Obviously, it's still sort of kind of positive contributor within your like-for-like. How are you messaging the sort of -- what your sort of preference on pricing will be with franchisees into the new year as well?

[David James Wild, CEO & Executive Director]

That's work in progress in terms of the conversation with franchisees around pricing. As I said in response to Doug's question, generally, the outlook on food is pretty benign. And if we get a material strengthening of the exchange rate against the euro as the result of a Brexit deal, then I think the outlook for food pricing, absent pork, is pretty good. But I think it's going to be in the range of 2% to 3% on food. The bigger challenge for franchisees is labor, where we're expecting the living wage to go up by 5% in April. And the government announced a couple of weeks -- I think it was at a Tory Party conference actually that they wanted 5 years of 5% living wage increases, and that they were going to roll back the qualification age for living wage from 25 to 21. So the pressure on our franchisees around labor is far greater than any other cost line. And that again links to my earlier point about collection and making sure that we properly use the labor and the resources that we have in the stores rather than continuing to chase delivery volume at peak time when we're already short of drivers. So I think the changing landscape on labor is the biggest cost challenge our franchisees will face.

[Heidi Mercia Richardson, Associate Director and Equity Research Analyst]

Okay. Great. Can I just also ask where you are on the JUST EAT [ trials ]?

[David James Wild, CEO & Executive Director]

It's finished.

[Operator]

Our next question comes from Nigel Parson of Canaccord.

[Nigel Andrew Parson, Analyst]

I wondered if you could just sort of comment a bit on the corporate store performance and our plans there. And any other moves, like sort of address swaps and so on, to unlock the enormous London potential.

[David James Wild, CEO & Executive Director]

The corporate store performance has been good in terms of order count. So we're pleased with that. And as you have seen, we have opened a number of stores over the last 15, 18 months. And in fact, I've got a meeting at 10:30 this morning, Nigel, on an address swap to unlock another territory in North London. So I think that's all moving reasonably well.And the carryout collection business in corporate stores is going particularly well. We still haven't quite got the balance right in terms of labor costs, but I'm encouraged by the performance in terms of sales and store openings.

[Operator]

[Operator Instructions] We have no further questions, so I'll hand back.

[David James Wild, CEO & Executive Director]

Thank you very much, Jordan, and thank you, everybody. Have a good day.