Chinese Restaurant Stock Analysis Series Part 3: DPC DASH (1405.HK)
Global giant trying to leverage its excellent leadership and tested strategy in the hyper-competitive Chinese market
Welcome to the third and final part of my Chinese restaurant stock analysis series. Today I’m covering DPC Dash, which is the sole operator of Domino’s Pizza in China. Now where do I begin with Domino’s Pizza; I like most people despise the taste of their pizzas particularly in my country where it tastes like industrial waste but there’s something that draws people onto it especially when they’re either hungover or piss drunk. Their pizza probably compels Italians to launch missiles against their headquarters. But things are quite different in China. Domino’s Pizza in China is quite eccentric to say the least with ‘‘appetizing’’ menu options like durian pizza (ugh) but as I experienced on my trip to China recently their pizza surprisingly tastes very fresh in stark contrast to their usual industrial taste.
What gets me interested in these Domino’s Pizza operators globally is Domino’s Pizza’s stock chart from 2008 to 2020 wherein they managed to beat everyone’s favorite PR company and hedge fund i.e. Apple in terms of compounded terms; there’s something in the business model which clearly resonates with customers and thus leads to them being rewarded generously by the market. So what differentiates Domino’s in China from Domino’s in the rest of the world:-
the main competitor, Pizza Hut, is disorganized, uninterested, and probably uninterested because Yum China loves milking its KFC brand which is super popular in China
its the only operator that has direct investment from DPZ US
excellent management
low store count relative to TAM and parabolic demand
While it isn’t profitable in the slightest I believe that it has the potential to either become the largest or the second pizza chain in China and this is due to the above listed reasons and more which I’ll elaborate on throughout the course of this article.
History Of Domino’s Pizza in China
Domino's entered the Chinese market in 1997, a few years after competitors like Pizza Hut (1990), KFC (1987), and McDonald’s (1990). Initially, the franchise was managed by a Taiwanese hotel company with an American CEO, but it suffered from underinvestment and poor management. By 2009, after 12 years, Domino's had only 18 stores in China. In 2010, American investor Frank Krasovec acquired the franchise, increased investment, and expanded to 100 stores by 2017. However, performance remained weak due to several key issues:
Delivery-Centric Model: Domino's relied heavily on delivery, but food delivery was not yet widely adopted in China. With many dining options nearby and a culture of home cooking, Domino's struggled to gain traction. Pizza Hut, on the other hand, focused on in-store dining with a Western restaurant vibe, which resonated better with Chinese consumers.
Underinvestment: Influenced by a “capital-light” approach, Domino's US (DPZ) avoided significant equity investment in China. This left franchisees under-resourced, unlike Yum Brands and McDonald’s, which heavily invested their own capital to establish a strong presence in China.
Lack of Localization: Domino's failed to adapt to the Chinese market, with frequent leadership changes and non-Chinese CEOs. It also operated with outdated IT systems, inefficient processes, and overstaffed stores, leading to mismanagement and poor performance.
Low Brand Awareness: Poor store performance and limited store count resulted in minimal investment in marketing, creating a vicious cycle of low consumer awareness and weak results.
This began to change in 2017 when Aileen Wang was appointed CEO. With experience at McDonald’s China and McKinsey, Wang assembled a strong team, many from McDonald’s, and implemented significant operational changes. Key developments included:
Rise of Food Delivery Apps: The emergence of platforms like Meituan, Eleme, and Baidu Waimai in 2015 revolutionized food delivery in China. This shift, along with the COVID-19 pandemic, made Domino's delivery-focused model more viable and boosted its brand awareness.
Increased Investment: Domino's corporate and other investors injected more capital, including $80 million from DPZ in 2020-2021. DPZ also took a 14% ownership stake, with a representative on DPC Dash’s board.
Localization: Wang’s team adapted the menu to Chinese tastes, introducing items like durian pizza, crayfish pizza, and lamb skewers, following the successful strategies of KFC, McDonald’s, and Pizza Hut.
Store economics: Improved store economics enabled faster expansion, increasing brand awareness and further enhancing store performance. This positive feedback loop positioned opening a DPC Dash as a decent opportunity for prospective business owners in China.
Thesis and potential
According to Domino's the main metric to track to understand the size of the market is pizza stores per population. Following their train of thought, China has the lowest number of Domino's stores per million people among the key markets for Domino's at 0.6 stores/million vs 8.2 in Japan, 19.5 in UK, 20.4 in the US, 1.4 in India, 7.1 in Taiwan and 9.3 in Korea
China also has one of the lowest pizza stores per million globally at 7.6 stores/million vs 22.8 in Japan, 71.4 in UK, 218.3 in the US, 11.5 in India, 24.6 in Taiwan and 156 in Korea. The total TAM for pizza restaurants in 2022 was estimated to be RMB 38bn with an expected growth rate of 15.5% CAGR to 2027
Pizza Hut has 3,411 stores across 750+ cities with an annualized store expansion of 450 stores as of 1Q24. In contrast, Domino's started 2024 with 768 stores and has penetrated a mere 29 cities. DPC's management has a target of opening 240 stores in FY24 and 300-350 stores annually for FY25 and FY26 with the goal of hitting 2,500 stores by 2028
From DPZ's comments the parent company has been gushing praise for DPC's management, essentially saying management was the main reason Domino's is currently doing well in China.
Domino's brand awareness in China has skyrocketed, leading to a frenzy whenever new stores open in previously untapped cities. These new locations are breaking records, with first-month sales surpassing Domino's global all-time highs, achieving payback periods of under 12 months (sometimes even under 6 months), and experiencing overwhelming demand, including two-hour wait times and high social media buzz. In some cases, new stores delay activating delivery services for months because they are inundated with in-person orders.
Initially, there was concern that this explosive performance might be driven by a fad-like phenomenon. My research indicates that this is not the case. Instead, it reflects pent-up demand in new cities for a strong brand and high-quality pizza that existing market options were not meeting. This demand is not fleeting, as evidenced by years of steady performance in saturated markets like Beijing and Shanghai. While new city sales gradually normalize over time, they do not experience sharp declines, and pizza remains a well-established category with enduring appeal due to its strong price-to-value ratio.
Customer feedback highlights Domino's superior taste, better price/value compared to Pizza Hut, and an exceptional delivery experience. Domino's uses dedicated, in-house riders in uniform, guarantees deliveries within 30 minutes (offering free food coupons if this is not met), and maintains an average delivery time of just 23 minutes. This speed is crucial in China, where most consumers lack ovens at home, ensuring the pizza arrives hot and fresh. These factors collectively reinforce Domino's strong position and long-term potential in the Chinese market.
Currently China has the lowest number of Domino's stores and pizza stores per million people compared to its peer group. The closest comparable country is India, which has 2.1 times more Domino's stores and 1.5 times more pizza stores per capita, despite China having 5.6 times the GDP per capita of India. However, it’s worth noting that Domino's India (Jubilant) took 10 years to grow from 750 to 2,200 stores, while DPC Dash is projected to expand from 768 to 2,000 stores in just 4 years—a target that may prove overly ambitious.
Looking at broader benchmarks, the median and average Domino's penetration rates globally are 8.2 and 11.7 stores per million people, respectively. For pizza stores in general, the median is 93.1 and the average is 106.9 per million people. Focusing specifically on Domino's, the range among selected peers spans from a minimum of 1.4 to a median of 8.2 stores per million people. My forecast of 2,000 Domino's stores in China by 2027 would bring the country to 1.4 stores per million, matching the minimum figure. If China were to reach the median of 8.2, the store count would rise to 11,500, potentially making DPC Dash a tenfold growth opportunity but I think this is a pipe dream and not realistic because Chinese are not that obsessed with pizza as compared to the rest of the world.
When considering pizza stores overall, the range extends from a minimum of 11.5 to a median of 93.1 per million people. If China’s pizza store count remains stagnant, DPC Dash would need to significantly increase its market share to reach the minimum benchmark. For instance, if DPC grows to 2,000 stores, its market share would rise from 8.4% to 16.9%, implying an annual increase of about 2 percentage points. This is an aggressive assumption, especially in China’s highly competitive market. That said, DPC’s revenue market share has already grown from 2.4% in 2019 to 5.3% in 2022, or roughly 1 percentage point per year. While not a direct comparison to store share, this growth indicates that Domino's is gaining traction in China, supporting the case for its expansion potential.
Here are some comments from Domino’s corporate (DPZ) on DPC’s management
On DPC Dash management:
“I was fortunate enough to serve as the DPZ representative on the Dash Board when we made that investment. That management team, as I've worked in the international business, pound-for-pound when you look at store count is one of the best that we have in the world when you think about operational execution and development discipline. I'd put that leadership team against any we have in the world.” – Joseph Jordan, President of Domino’s Pizza US and Global Services, 9/13/2023
On China store potential:
“I was actually just in Shanghai last week, and I can tell you, every time I visit this market, I come away even more energized and more confident about the future of Domino's in China. China and India combined over the next 5 years will deliver slightly less than half of our store growth.” – Art D’Elia, EVP of International for Domino’s Pizza Inc, 12/17/2023
“The growth that we can see coming in China is just unbelievable and astronomical in terms of relative to where we are, the potential growth is very, very strong because the economics are very compelling. And it's a highly developed QSR market where the demand for the Domino's brand is very high. So we continue to see a very strong appetite, not just in Tier 1, Tier 2 cities, but Tier 3 cities and wherever we're actually opening up stores. There's a lot of potential for us to continue to put down more and really apply the fortressing approach to drive much more density and much more growth in the China market with the size of potential stores that we haven't open yet being very significant relative to where we are right now.” –Sandeep Reddy, CFO of Domino’s Pizza Inc, 6/14/2023
Now if we’re being realistic and involving our usual bucketload of conservatism here then the question marks start arising and I’ll explain this in the next part.
How realistic is their expansion?
DPC Dash may not need to grow its market share by 2 percentage points annually because the broader pizza market in China is also expanding. Its main competitor, Pizza Hut, which operates 3,400 stores, opened 409 stores in 2023 and 113 stores in the first quarter of 2024, putting it on track to open around 450 stores in 2024. If Pizza Hut maintains this pace, it would add 1,800 stores by 2027, reducing DPC's projected market share from 16.9% to 14.7%. This means DPC would only need to grow its share by 1.6 percentage points annually, rather than 2.
However, even a 1.6 percentage point annual growth rate is 60% higher than the 1 percentage point growth DPC achieved over the past three years, making it a challenging target. That said, DPC’s historical growth was achieved as a private company, and its IPO in March 2023 provided fresh capital to accelerate expansion.
The capital expenditure required per store is RMB 1.54 million. At the end of 2023, DPC had RMB 1 billion in cash, including RMB 0.5 billion raised from its IPO, which is sufficient to fund an additional 650 stores. This would bring the total store count to 1,418 (from 768 at the end of 2023) without generating any additional cash flow.
To reach the target of 2,000 stores by 2027, DPC would need to fund an additional 582 stores, requiring RMB 896 million. In FY23, the company generated RMB 209 million in operating cash flow with 768 stores, 31% of which were opened in 2023. DPC plans to grow its store count by approximately 30% annually for the next two years and 22-27% in the following two years, maintaining a similar proportion of new stores as in 2023.
To be conservative, assuming operating cash flow grows by 20% annually to account for a higher mix of stores outside Beijing and Shanghai, DPC’s cash flow would increase from RMB 209 million in FY23 to RMB 251 million, RMB 301 million, RMB 361 million, and RMB 433 million from 2024 to 2027, totaling RMB 1.35 billion. This is 50% more than the RMB 896 million required to bridge the gap, supporting the feasibility of the expansion plan.
Valuation
This is what puts me off from this investment because it requires a lot of imagination and hope; two things I don’t have much of especially from this hyper competitive market.
If you assume that same store sales growth is comparable to their peers at 3-5% which is realistic and conservative accounting for the high competition in the restaurant industry even then I find it hard to come up with a net profit margin figure for the business. Unlike a Luckin Coffee which is consciously low margin and can hyper scale due to its small store format because I mean unlike what Starbucks would have you believe, you don’t need a large 3000 square foot restaurant to make coffee, a Domino's store requires more area. Also DPC’s recent surge in popularity may as well not last despite several signals pointing otherwise because popularity can be very short lived in China where trends change really fast unlike the US. Can DPC become profitable and have margins of between 5-7%? possibly but what are the odds of that happening? I struggle to imagine it.
If all of the above assumptions come true and DPC has a future net profit margin of 5-7% then you might earn a 12.6 compounded return but I think there are frankly way better opportunities in the Chinese market at much cheaper prices so I’m not going to be personally buying this but it might suit some of you.
Conclusion
Well folks that brings us to the end of this series. Thank you so much for your overwhelmingly positive feedback and I never expected that I would have this many subscribers so soon. Please let me know what you would like to see from me next. I outlined a list of ideas in one of my notes and if you’re interested in one of those then either comment on one of my posts or DM me. I’m also open to other suggestions and would love to hear from you.