Why we sold Domino’s Pizza

Charlie Huggins (CFA) - Fund Manager

26 June 2019

We have decided to exit our position in Domino’s Pizza. The shares had been held in both the Select UK Growth and UK Income funds since launch.

Why did we buy Domino’s?

Domino’s had an exceptional long term track record of growing sales, profits and dividends. At the time of our initial investment, we saw little reason why this track record wouldn’t be maintained.

The company had a strong brand, squeaky-clean balance sheet and was highly profitable, throwing off cash. Relationships between the plc and the individual franchisees who ran the stores appeared strong, existing stores were growing sales nicely and new store openings were at an all-time high, propelling sales and profits higher.

What went wrong?

Unfortunately, progress over the last couple of years has been disappointing. Sales in existing stores have weakened, franchisee relations have become increasingly strained and new store openings have slowed. The group’s international business, while small in the grand scheme of things, has performed poorly, losing over £4m in 2018.

Unsurprisingly, sentiment towards the company has weakened and the shares have come under pressure.

Why are we selling now?

We don’t view any of the above issues as insurmountable, but we struggle to see a resolution at the moment, particularly under the current management team.

We think quite a lot of the group’s problems are of its own making and could potentially have been avoided. In particular, we have been surprised at the level of turnover at the top, with three finance directors departing the company in quick succession.

We do not agree with the group’s decision to take on debt to buy back its own shares and while we can forgive some deterioration in franchisee relations during a period of rising costs, we think the overall situation could have been better handled.

Indeed, relations have become so bad that Domino’s franchisees have commissioned an independent audit into how the group spends its advertising budget.

Competition in Domino’s market is also intensifying. Consumers now have much more choice when it comes to ordering takeaway food - at the click of a button they can get anything from a Chinese takeaway to a restaurant-quality meal delivered directly to their home.

This choice has been enabled by the so-called online aggregators (Just Eat, Deliveroo and Uber) whose websites provide a wide selection of independent and branded restaurants. All of these firms continue to invest aggressively into expanding the number of restaurants on their platform, particularly branded chains such as McDonald’s, KFC and Burger King – all credible alternatives to a takeaway pizza.

While we still like Domino’s business model, the combination of the above issues leaves us feeling less confident in the group’s future prospects, hence our decision to sell. In total, over the two years we invested in Domino’s, our position cost each fund about 1%.

Lessons

We will never get every decision right but we will always seek to learn lessons from our mistakes. In the case of Domino’s, we probably attached too much weight to the strength of the business model and track record, and we should have paid more attention to the quality of management and the changing competitive dynamics.

We are doing an increasing amount of work to understand the management and culture of the businesses we invest in to try and further improve our process. We seek to own high quality businesses benefitting from a virtuous circle of growth, stewarded by highly capable management teams, with strong corporate cultures.

We believe we own many such businesses in the HL Select funds and we hope to find more of them.

What have we done with the money?

In the HL Select UK Income Shares fund we’ve used the proceeds from the Domino’s sale to reinvest in existing positions. While in the HL Select UK Growth Shares fund we’ve used the money to start a new position, which we believe has great long-term prospects. We’re still building this position but once it’s up to size, we’ll let you know exactly what we’ve bought and why.