Jubilant Foodworks (JUBI IN)

Short summary of the key points discussed in this note (each elaborated in more detail later)

Investment Positives

1. Domino’s gaining share globally in the QSR pizza segment with substantial share gains in pizza delivery
segment which is growing faster than dine-in. Has built durable competitive advantages using
continuous product innovation, technology investments, data driven decision making and a consistent
customer experience. Initiatives such as ‘fortressing’ are helping widen the moat.
2. Domino’s India business (JUBI) has seen strong execution over the last three years under the new mgmt.
with improvement in unit economics driving strong SSSG and improvement in profitability. Further, the
company is well placed to leverage the post COVID tailwinds due to strong brand equity and solid
delivery capabilities.
3. JUBI has superior financial return metrics (10-year avg. ROCE of ~40%) with strong cash flow conversion
(negative working capital cycle). Being debt free, it is well placed to ride out a weak FY21 and can
potentially grow earnings in high teens in later years if it continues to execute well.

Investment Negatives

1. At 1300+ stores, India already has the second highest number of Domino’s stores after the US. This
raises some questions on the longevity of store addition led growth. Domino’s US’ investor presentation
put’s India’s potential store count at 1,800 stores only (a number unchanged over the past five years).
There is a risk that the management drives store addition growth via non-Dominos formats which can
be dilutive to earnings and value.
2. Partnering with Swiggy/ Zomato has given substantial sales push over the last two years. However, this
carries risks as S/Z become sizeable of overall delivery sales and may ask for higher take rates. This also
incentivizes existing Domino’s app users to digress to S/Z which dilutes the ‘Domino’ experience.
3. As investors, we are most interested the free cash flow generated by the Domino’s franchise which has
high core ROCE and needs capital investment. Digression of this cash to incubate and test newer
formats such as Dunkin and Hong’s kitchen is risky. We need to know if these large capital allocation
decisions are promoter driven (grandiose) and the management is duly consulted.
4. It will be interesting to know if JUBI is planning to explore (and if not why) sub-franchising as an option
which is an absolute norm globally with all master franchises. There are numerous advantages of this
which I have discussed later in detail.
5. JUBI’s board seems compromised. There has been no change in the board (including independent
directors) despite the promoter royalty issue which happened last year. Half of the board comprises of
promoter family and the CEO (potentially complicit) with the remaining five independent directors
seemingly not in a position to speak up for minority shareholder interests.

#1) Are they only selling pizzas, or do they have strong competitive advantages?

Before analyzing the India Jubilant business, it is important to step back and ask ourselves – what makes the
Domino’s brand successful globally. If the parent brand is doing the right things they will eventually reflect as
best practices being replicated by the master franchises. Let me elaborate on the undersigned with a few facts
on the global reach and success for the Domino’s brand.

1. Dominos is the world’s largest QSR pizza chain with a global market share of ~15% in QSR pizza.
Domino’s total retail sales globally are ~US$15bn (17,000+ stores) and they overtook Pizza Hut in 2018
after being number two for several years prior. ~US$7bn sales accrue from international markets
outside the US highlighting the global brand acceptance.
2. Large sales by themselves do not mean much if they don’t help the ecosystem make money. All
Domino’s companies (parent as well as master franchisees in individual regions) make more than
acceptable ROCEs in their individual markets.
Jubilant Foodworks (JUBI IN)

Below is the ROCE profile of the four largest listed Domino’s entities globally. I have not included the South
American franchise since they also own several other brands.

Market Cap
Listed Entity Name Nature of operation # stores (US$ bn) ROCE
Domi nos US (DPZ) US s tores and gl obal brand franchi s or 6,200 14.7 113%
Mas ter franchi s e i n Aus tral i a, Japan and
Domi nos Pi zza Enterpri s es (DMP ASX) Parts of EU. Sub-franchi s es further. 2,600 3.4 93%
Domi no's Pi zza Group (LON) UK and Irel and - s ub franchi s es further 1,300 1.9 55%
Jubi l ant Foodworks Indi a - does not s ub franchi s e 1,335 3.0 56%

3. Making pizzas is not Domino’s main differentiator. The key differentiator is being able to run a very
successful and profitable pizza delivery operation. The Domino’s brand is synonymous with ordering
pizzas and getting them delivered within 30 mins (with low variance) and in acceptable condition (warm
enough with no damage to the packaging).
4. Several players operate in the restaurant business (albeit with a high failure rate) but few are able to
succeed in the delivery operation. This is evident from the fact that Domino’s pizza delivery market
share in the US is 35% versus 20% share in overall pizza QSR market. More importantly, their market
share in Pizza delivery share has moved 10ppts over the last five years (from 25% to 35%). These shar
gains in pizza delivery have accrued from Pizza Hut, Papa John and other chains.
5. The US QSR pizza delivery market is consolidated with top 4 players taking up 60% market share
(Dominos leads) while the overall pizza QSR market including dine-in is more fragmented with top 4
players making up ~40%. This suggests ‘many make pizzas but few now how-to deliver it well’’.

#2) Identifying competitive advantages / moat

We have argued earlier that Dominos globally has been gaining share in the overall pizza QSR segment on the
back of high share gains in pizza delivery. Clearly there are some competitive advantages which we attempt to
identify below.

1. Most efficient pizza delivery operation: Domino’s delivers in time with full ownership of customer
experience (since they own both the product and the delivery network). Standalone restaurants own
the product but don’t control the delivery which means the product delivery could be delayed or
delivery condition is not consistent. On the flipside pure delivery companies (like Swiggy) control the
delivery but not the product itself (its quality, time to preparation). Dominos guarantees a consistently
good experience both on the product and on the delivery.

2. Designed as a food delivery company; life depends on it: Domino’s started primary as a pizza delivery
operation in the 1960s and has perfected the art and science of pizza delivery. No other company has
spent such a long time focusing only on delivery. Domino’s in the US has insignificant dine in sales, so
the entire focus of the business is continuing to better the time to delivery and customer experience.
Jubilant Foodworks (JUBI IN)

3. Technological edge over competition:

a. Domino’s has invested over the years in ‘easy to use’ online ordering systems on the web as
well as via its mobile app. Results are evident – Online sales contribute more than two thirds
of the sales in the US and more than half of sales globally. In India also this number is above
50%’(as a share of overall sales). As per Domino’s US 2019 Annual Report – they are among the
largest e-commerce retailers in terms of annual transactions.

Dominos is the best ranked food ordering app in India (beating Swiggy and Zomato)

# Rank by rating Mobile App Downloads Rating (out of 5) # Reviews (mn)

1 Dominos India 30m+ 4.3 0.50
2 Swiggy 50mn+ 4.2 1.00
3 Zomato 100mn+ 4.2 4.00
4 Fasoos 5mn+ 4.1 0.10
5 MCD India 1mn+ 3.9 0.04
6 KFC India 5mn+ 3.2 0.02
7 Pizza Hut India 0.5mn+ 3.1 0.02

b. There have been technology investments at the back end as well which enables optimizing
order processing, identifying optimal new store locations and improve delivery efficiency. A
lot of the decisions are data driven which get better as more pizzas are ordered (mild network
effects at play).
4. Scale advantages help deliver ‘value for money’: Domino’s pizzas rate high on value on money. This is
a bit like burgers from McDonalds. What helps achieve is this is the large scale of the back-end supply
chain and commissary network.

#3) Is the moat widening or shrinking?

1. Delivery growing faster than dine in most markets: Globally, delivery and carry out segments are
growing faster than dine-in (source: Domino’s US company presentation). This is the case in India as
well as has been acknowledged by the India management. Dominos being a delivery led business is thus
well placed to outgrow small local chains and other QSR chains with a weaker delivery presence. This
will mean more app downloads, more customers, more data, larger scale benefits.

2. Fortressing a sound strategy to deepen the ‘core’ competitive advantage: Fortressing (opening more
stores in areas where demand is going through the roof) seems to be a good strategy which further
enforces the USP with customers (quick and reliable delivery), reduce cost and time per delivery. This
is nothing but an attempt at widening the moat. Fortressing efforts world over have been successful
with the two new stores eventually outselling the old store in quick time.

Below is an example of how fortressing works

Jubilant Foodworks (JUBI IN)

#4) India business – Jubilant Foodworks

1. What is needed? The Domino’s template seems to be working well globally and the India business
largely needs is to replicate the same. What is needed is for someone to emulate the best practices at
the front end and the back end while being flexible to factor in local nuances where needed (in terms
of menu, hiring, identifying locations). Focus on unit economics and store level profitability is key given
the fixed cost nature of the business.
2. Pure dine-in struggles in India; indexed to delivery is an advantage: The dine-in restaurant model has
struggled in India primarily due to high rental and capex and lack of commensurate throughputs. High
rentals are also the main reason why departmental chains find it hard to make money. In that sense, a
well-run delivery operation becomes a competitive advantage. First level thinking is that delivery has
extra costs, but one needs to factor the rental/utility savings (smaller store sizes) and low on-remise
staff requirement. Besides, scaling up with new store adds is easier when store sizes are smaller (avg.
Domino’s is much smaller than avg McDonalds). Also, location as a factor for success becomes less
relevant for a delivery led model compared to pure dine-in formats.
3. Some concerns on the company are as follows

a. Scalability and size of operations: The headroom for Domino’s to grow in India seems large at
first thoughts. My concern here is whether they have already become too large in India?
i. India is now the second largest market for Domino’s globally after the US (in terms of
store count). At 1300+ stores, India is by far the largest international Dominos
franchise business. The Indian operation is even larger when one considers the fact
that most other regions have sub franchises (master franchises further sub-
franchise). For example, in the US, the largest franchise has 176 stores out of the total
US store count of 6500+ stores. So, the Indian operation is already the largest run
under one management/ owner.
ii. This also shows up when we compare the current and potential store counts in each
country as presented by the respective country mgmts. in an investor presentation
made by the parent entity in the US (May 2020). Growth potential in India is lower
than several other markets at just 35% from the current base. The caveat is that the
store potential must be a moving target every few years and is subject to judgement
by the local managements. However, the number for India (1800 potential stores) has
not changed for the past five years i.e. 2016-2020. While the presentation does not
specify a target year, assuming these are five-year targets, India’s implied 5-year store
CAGR is ~6% which seems much lower than what most investors would expect. We
probably need to check with the India mgmt. on how this number was calculated and
whether it is too conservative. Another likely reason could be that incrementally,
Jubilant mgmt. intends to focus a lot on the store addition in other formats such as
Dunkin and Hong’s Kitchen.

Below is a slide from Domino’s US May 2020 Investor presentation

Jubilant Foodworks (JUBI IN)

% growth 5 yr store
Country Current Store Count Potential Store count headroom CAGR
Chi na 275 1,000 264% 29%
Germa ny 321 1,000 212% 26%
Bra zi l 259 750 190% 24%
Fra nce 414 1,000 142% 19%
Sa udi 261 450 72% 12%
Aus tra l i a 701 1,200 71% 11%
Turkey 550 900 64% 10%
Ja pa n 663 1,000 51% 9%
UK 1,130 1,675 48% 8%
Ca na da 512 700 37% 6%
Indi a 1,325 1,800 36% 6%
Netherl a nds 295 400 36% 6%
Mexi co 797 1,025 29% 5%
South Korea 443 500 13% 2%
Spa i n 321 350 9% 2%

b. Partnering with Swiggy/ Zomato may dilute what the brand stands for: The Domino’s brand
stands for the whole pizza experience – including using the Dominos mobile app and then
expecting a Dominos dressed delivery man ring your doorbell in less than 30 mins. Ideally what
you want customers ordering from the Domino’s app and not aggregator apps. You then want
to ‘vow’ these customers on multiple fronts – a very well-designed app with rich innovative
features (higher rated than any other food ordering app), targeted discounts basis past
ordering patterns etc. Letting S/Z take orders on your behalf can help near term growth but
have long term issues such as below
i. Customers ordering via Swiggy/ Zomato are ‘their’ customers who just chose to order
Domino’s that day. They are unlikely to be repeat users.
ii. Over time the share of aggregators in delivery orders (already substantial at ~35% in
such a short time) may increase creating several issues. a) They may seek upward
revision of take rates. b) existing Domino’s app users may also move to Swiggy/
Zomato for future ordering c) This could lead to slackening of developmental efforts
by the Dominos team on their app if incremental growth is driven by aggregator apps.
Jubilant Foodworks (JUBI IN)

iii. Perhaps it’s worth exploring the more strategic reasons why Domino’s US did not tie-
up with aggregate platforms. Domino’s US is also a growth-oriented company with
98% stores franchised out. So, each franchise sure won’t mind some extra short-term
orders via aggregator apps.

c. No getting away from high operating leverage of the business: It’s worth highlighting that
the business revenue is not very cyclical per se – Dominos pizza is not luxury and people will
have pizzas during bad times. But the fixed cost nature of the business renders the earnings
and ROCE profile very cyclical. The risks from slowing SSSG rise substantially when the
company is entering a high store addition phase (like it will likely enter over the next three
years starting FY22)

EBIT (Rs mn) (RHS) SSSG (LHS) ROCE (LHS)

60% 5,000
4,500
50%
4,000
40% 3,500
3,000
30%
2,500
20%
2,000

10% 1,500
1,000
0%
500
-10% -
FY2013 FY2014 FY2015 FY2016 FY2017 FY2018 FY2019 FY2020

d. Capital allocation concerns:

i. Who makes the large capital allocation decisions: Such as launching new brands like
Dunkin and Hong’s kitchen? Does it come from the Bhartia’s or professional
management? As potential investors we should be aware of whether it’s purely a
promotor call or the management is also well on board. This is relevant because there
is an existing strong Domino’s business which has a higher core ROCE, a large total
addressable market and needs capital (capex, tech, marketing).
ii. Prudent capital allocation suggests re-investing in the existing business rather than
incubating new ones. Domino’s US annual report says that usually discourage their
franchises from operating any other business. Jubilant has already had a bad
experience with Dunkin in the past. It might be in the promoters interest to build a
portfolio of brands (funded by FCF from Dominos in which minority investors have
interest) – promoters can get over ambitious from time to time but it may be in the
interest of minority shareholders that any excess cash go back into Dominos only.

“In addition, we generally restrict the ability of U.S. franchisees to be involved in other businesses, which we
believe helps focus our franchisees’ attention on operating their stores. We believe these characteristics and
standards are largely unique within the franchise industry and have resulted in qualified and focused franchisees
operating Domino’s stores.” - Dominos US CY19 AR

iii. We want to know how much of the incremental stores opened, management
bandwidth and capex would go into new brands and countries over the next 5/10
years. Current share of capital employed in non-Dominos’ stores is less than 5% but
would it incrementally be much higher? The snapshot below from JUBI’s FY19 annual
report gives some cues.
Jubilant Foodworks (JUBI IN)

Key business strategy pillars

e. Why not exploring sub-franchising model in India: Domino’s has a tried and tested model of
franchising and further sub-franchising globally. In all regions including those running master
franchises (except India), stores are run by individual franchisees (mostly former employees
including delivery boys). Attempting to franchise is a double-edged sword but Domino’s seems
to have a successful template globally. Below are some advantages of sub-franchising
i. Makes the master franchise’s business asset light with low operating leverage– sub-
franchises pick the tab on store rentals, deposits, staff and utility costs. Master
franchise earns money through royalties, training and ingredient supplies to sub-
franchises.
ii. Master franchise can invest all the time, management bandwidth and resources into
local product innovation, technology and optimizing supply chain. Master franchises
own some stores themselves to try pilot initiatives and keep in touch with on the
ground realities of running the business.
iii. 95% of US franchises started as former drivers or hourly workers. This strategy helps
a) attract people with low initial wages given the upside if one does well (great
defense against poaching) b) have your stores run by people who know the nuts and
bolts of the business grounds up and are entrepreneurial (incentives better aligned
than could be the case for any corporate employed store manager – I know in India a
delivery boy can become a store manager).
iv. Do we know as to why Jubilant is not willing to try this out in India? Or have they
given it due consideration as an option. If they do implement it, this can potentially
drive higher ROCEs in the future. They would not do it if they are very confident of
the future for Domino’s stores. In that case, I would take them back to my capital
allocation question above (why try newer untested formats).

f. Concerns with the promoter group and board independence:

i. The royalty issue which cropped up in Feb 2019 is a major red flag. Promoters wanted
to take out some cash every year (0.25% of sales) as a royalty for providing the
‘Jubilant’ brand. Shockingly, this action was not put to vote by minority investors as
it was classified internally as ‘business as usual’. The board and the CEO seemed to
be complicit with the promoters as none of the independent directors raised any
questions. Typically, after such a public debacle, one would have expected the board
Jubilant Foodworks (JUBI IN)

to change or at least have some new independent directors. But no such changes
have taken place. Out of the 10 board members, 4 are promoters. The other 6 include
the CEO and the same 5 independent directors who could not prevent the promotor
royalty being slapped.
ii. None of the independent board members own stock in the company and earn sitting
fees. Warren Buffet’s lament about board independence in the 2019 letter come to
mind. Board members don’t own any stock and earn high sitting fees (no incentive to
serve interest of minority shareholders who they represent).
iii. Need some comport on group leverage and financial health of other group
companies. Promotor stake has been coming down although the pledge is now very
small.

4. Key earnings and value drivers:

a. SSSG is the single most important driver for profitability. An SSSG of atleast 4-5% is needed
every year to cover fixed cost inflation. Which is why driving volumes via a solid product
experience is paramount. On a normalized basis, JUBI can deliver 7-9% SSSG if they do well.
b. Store addition is the most important value driver (market cap creation) but adds real value
only if the SSSG remains defensible. JUBI can add stores at 8-10% over the next few years
which is also what street is expecting. My concern is that at this rate, they will reach the earlier
sighted store potential (1800) within the next five years. Store addition mix would also be
important. Domino’s stores added in India would be accretive to value and earnings but if the
mix is skewed towards outside India Dominos stores (Sri-Lanka) or formats such as Dunkin and
Hong’s – market will not give credit and infact may penalize the stock. Unless there is hard
data these formats are working. Which is again why the capital allocation question becomes
important.
c. Margins: The highest ever EBIT margin reported by JUBI was 14.7% in FY20 when the SSSG was
30%. The next best EBIT margin of 12.9% reported was in FY19 when the SSSG was 16%. Thus,
assuming an 8-10% (steady state) SSSG in FY23, an EBIT margin of ~16% seems possible but
less probable. One must also bake in the drag from a ramp up in Dunkin and Hong’s Kithcen
Stores.

EBIT margin (LHS) SSSG (RHS)

16% 40%

14% 35%

12% 30%
25%
10%
20%
8%
15%
6%
10%
4% 5%
2% 0%
0% -5%
FY2010 FY2012 FY2014 FY2016 FY2018 FY2020

d. Solid cashflow profile: JUBI is among the few ‘retail businesses’ with negative working capital
(negative 30 days) which means you get more cash for selling more pizzas. Average 10-year
Jubilant Foodworks (JUBI IN)

CFO/PAT is 200% for the company. Average 10-year FCF/ Sales is ~65%. This has meant that
that business has remained debt free while being able to re-invest for growth. Average 5-year
dividend payout ratio is ~25%.

5. Comments on valuation:
a. I have tried to conservatively gauge earnings five years out and then assign a reasonable 45x
one-year forward earnings multiple. My earnings trajectory is a bit conservative assuming a
sharper dip in FY21 and less sanguine margin improvement trajectory thereafter. This
generates an IRR ~12% from the current market price including dividends.

Conclusion:

1. As argued earlier, I like the Domino’s business in terms of what they are doing globally and their solid
execution in India under Pratik Pota. My main concerns emanate around 1) store potential for
Domino’s in India given the already large current size 2) future capital allocation b/w Dominos and non-
Dominos and who drives these decisions at the top level 3) lack of board independence.
2. With a clear understanding and comfort around these issues, this can be an investible story. Ideally, I
would want built in a higher margin of safety to account for the inherent earnings cyclicality and
somewhat tainted promoter track record.