Profitability Ratios

Discuss about the Fundamentals Of International Financial Accounting.

Domino’s Pizza Inc. is an America based pizza restaurant chain, having its headquarters situated in Michigan. It was founded in 1960 and today it is the largest and leading pizza seller all over the world and in United States. It also considered as a best pizza delivery company in the world having exceptional people as employees.  It operates 14,800 stores in more than 85 countries as per the data of quarter 4 2017. Most of the revenue of the company is generated from outside U.S and its global sales in 2017 are reported at $12.2 billion out of which, $6.3 billion are from international markets. Pizza Hut is considered to be close competitor of Domino’s as it is also operating in the same business and same industry (Biz.dominos.com. 2018). 

The following report will critically analyse the financial position of Domino’s as well as compare it with its toughest competitor and industry standards. The analysis is done by calculating various financial ratios based on the annual reports of the company. At last, investment advice is also been given regarding investing funds into Domino’s Pizza Inc. 

These types of ratios helps in determining the profit situation of the company. The income statement of Domino’s provides essential facts about its financial situation as well as the profits earned by the company. Domino’s has a continuous increase in its net profits and profit from the operations. However, the company has a negative equity (Buckland and Davis, Eds. 2016). 

A brief summary of all the ratios is been provided here

Domino’s Pizza Inc.	2014	2015	2016	2017
Gross profit %	29.8%	30.9%	31.1%	31.1%
Operating profit%	17.3%	18.3%	18.4%	18.7%
Net profit %	8.2%	8.7%	8.7%	10.0%
Return on Equity %	-26.7%	-21.4%	-22.8%	-12.0%

Table 1: Summary of Domino’s profitability ratios 2014-2017

(Financials.morningstar.com. 2018).

A continuous increase is been noticed in the percentage of gross profit. In 2014, it was 29.8% and the same figure turnout to be 31.1% in 2017. This is due to the large increase in the revenue earned by Domino’s, mainly from its international markets. In 2017 quarter 4, its international sales were $6.3 billion out of the total revenue of 12.2 billion.

This ratio has also increased from 17.3% in 2014 to 18.7% in 2017. However, generating more revenue lead to increase in the cost also. Domino’s operating expenses has increased over the year. Reason being the changes in the product as per the customer taste and preferences, bringing new taste in the product as per the demand. All these led to the increase in cost of ingredients which affected its operating cost.  

Comparison with Competitor

Positive trends are been noticed in the overall net profit of the company. In 2014, it was reported at 8.2% and the same figure in 2017 was at 10.0%. This 2% increase is due to the rise in revenue and the customer focus strategies used by Domino’s. A 13% change was noticed in the sales of the company between 2016 and 2017, which eventually boosted up its profits.

It is that profitability ratio which shows company’s ability to generate returns from its shareholder’s equity. In Domino’s case, the trend is reverse as the company has negative value of the equity all over the four years. The reason of having a negative equity is the long term debt of the company which continues to rise from 2014 to 2017. In 2017, the long term debt was $3121 million which in 2014 was $1524 million. A negative ROE means company is generating negative returns for its shareholders.

One of the closest competitor of Domino’s Pizza Inc. is Pizza Hut. The company also operates a pizza chain all over the world and provide delivery services. The parent organization of the company is Yum Brands. Being a toughest competitor, its gross margin is also more than Domino’s.

Figure 1: Gross Profit % Domino’s vs. Pizza Hut

Similarly, comparing the net profit margin, Pizza Hut has high net profit than Domino’s, may be because the company control its cost efficiently and effectively.

Figure 2: Net Profit % Domino’s vs. Pizza Hut

These ratios considers the assets of the company which are been utilized for the purpose of generating profits. The following ratios are been determine to measure the efficiency of Domino’s (Hussey, 2011). 

Receivable days versus Payable days

Figure 3: Receivable days vs. Payable days

The above figure shows a comparison of days taken by Domino’s to collect its receivables against payable days. It can be observed that collection days remains almost same and in 2017 they were 22.5 days. On the other hand, payable days have reduced after 2015 and come to 20 days in 2017. However, the payable days are more than the receivables which means company is not efficient enough to collect its debtors timely. But in 2017, the trend got reversed because of the reduction in the accounts payables of the company.

From table 2, the inventory days of Domino’s has decreased which gives essential information to the investors and creditors. The reduction shows that company is efficient in converting its inventory into cash quickly. On the other hand, Pizza Hut’s inventory days has also reduced to a great extent and the reduction is more than the domino’s. Comparatively, Domino’s has less efficient inventory management due to the increase in value of stock in last two years.

Inventory days	2014	2015	2016	2017
Domino’s Pizza Inc.	9.8	8.7	8.4	7.5
Pizza Hut	11.0	8.6	3.5	1.5

Efficiency Ratios

Table 2: Summary of Inventory Days

The ratios shows the capability of the company to meet its short term financial obligations with its current and quick assets. Current and acid test ratio is calculated for assessing the liquidity position of Domino’s Pizza Inc. (Jenter and Lewellen, 2015).

The ratio which evaluates business ability to pay its liabilities with its current assets is known as current ratio. While, quick ratio does not consider the amount of inventory take into account only the liquid assets of the company (Periasamy, 2009). 

Domino’s Pizza Inc.	2014	2015	2016	2017
Current Ratio	1.61	1.60	1.23	1.46
Quick Ratio	1.47	1.51	1.13	1.36

Table 3: Summary of Liquidity ratios

(Financials.morningstar.com. 2018).

Table 3 shows that the current ratio of Domino’s has reduced over the years. In 2014, it was 1.61 and in 2017 it was reported at 1.46. Whereas, fluctuations are noticed in the quick ratio due to the increase in the current assets and inventory. However, the company has maintained a ratio of more than 1 and is able to pay off its liabilities with its current and quick assets.

From the below figure, it can be seen that when comparing the ratios with Pizza Hut, Domino’s has high current and quick ratio in the years 2014 to 2016. However, a continuous rise in both the ratios of competitor company is been noticed and in 2017, the trend got reverse. In the recent past year, current and acid test ratio of Domino’s was less than Pizza Hut, reason being the reduction in the current liabilities of the company. Though comparatively, Domino’s has better liquidity position.  

Figure 4: Liquidity ratios

These ratios helps in assessing the financial strength of the company. It allows for a financial comparison between the funds borrowed and the ones which came from investors. Generally, debt-equity ratio is used as a measure and a high ratio implies that company has greater financial risk (Saleem and Rehman, 2011).

Debt to equity

It shows the proportion of debt against company’s equity. The following figure will reflect the debt equity of Domino’s over the past 4 years.

The debt to equity ratio of Domino’s is negative because of the book value of equity is negative. This is due to the decrease in assets and increase in liabilities of the company. Another reason is the figures of retained earnings which are reported negative in the balance sheet of the company. This implies that Domino’s does not have enough equity funds and assets to meet its financial obligations. Hence, it can be risky to invest in such company. A negative ratio also indicates that company has a high financial risk as it is not able to pay its debt.  

Liquidity Ratios

From Figure 7, Pizza Hut’s ratio is more than Domino’s in year 2014 and 2015. After that company has no or negative debt equity ratio. The high ratio of Pizza Hut indicates that most of the company’s assets are financed through debt rather than equity. It means it possess high financial risk. The reason for having no ratio in rest two years is the negative value of equity reported on the balance sheet of the company. So it can be said that both the companies are not efficient enough in their debt management.

Under this, the ratios calculated are earning per share and price earnings ratio. EPS is a fundamental measure of share performance, determine the earnings generated and available to the shareholders on each and every share. Price earnings ratio basically compares the earning per share of the company with the market price of its company’s stock (Vogel, 2014).

The above figure 8, shows that EPS of Domino’s Pizza Inc. has steadily increased over the years due to the increase in the net profit of the company. However, the year-end share price of Domino’s has reduced in 2017 as compare to that of in 2016. On the other hand, fluctuations are been noticed in P/E ratio of Domino’s. In 2017, it was 32.5 and the same was 36.6 in 2016. This reduction is due to the decrease in the share price of the company between 2016 and 2017. The EPS has increased which means company’s share are able to generate more earnings.

When comparing EPS of different companies, one must keep in mind the fact that earnings are influenced by management and different accounting policies. Also the capital structure of the organization effects its EPS in way of change in the number of share issued. The table below reflects a comparative view of the EPS of Domino’s and Pizza Hut.

EPS	2014	2015	2016	2017
Domino’s Pizza Inc.	2.86	3.45	4.30	5.79
Growth %		21%	25%	35%
Pizza Hut	2.32	2.9	4.1	3.77
Growth %		25%	41%	-8%

Table 4: Summary of Earnings per Share

Domino’s EPS is better than Pizza Hut as there is a constant growth with the increased percentage. Facts that contribute to this upsurge is rise in revenue of international markets and increase in profits. Yahoo finance reported that, higher supply chain revenues, positive currency impacts and high royalties from retail sales boosted up the sales of quarter 4 2017. Apart from this, increase in the number of years last year and adoption of equity-based compensation accounting standard also contributed in the same (Research, 2018). 

Debt-Equity Ratio

One initiative Domino’s can take to improve its position of shareholder’s equity is to increase the number of outstanding shares. Common stock is included in the equity portion of company’s balance sheet, and when the company issues new stock, it increase both the number of shares and the paid-in capital of the company. The new stock offering rises the dollar amount of the shareholders’ equity by the amount of outstanding shares sold. This will directly impact the debt-equity ratio of the company and return on equity ratio. Also the net profit will increase which makes the negative ratios positive. Once the value of equity turns positive, the ROE will also become positive and also it will reduce the debt portion of the company. Reason being, will now have equity funding also for its assets and operations. Overall, issue of new shares will improve company’s profitability and financial strength to a great extent.

There are basically two methods used for valuation of shares. These are market value and book value. As per the information, Pizza Hut wants to buy 15% of Domino’s shares. For the purpose of which value of the shares is been calculated as follows:

This is commonly used by the investors as it shows the net worth of the company. It is reflected as assets and liabilities and is calculates as per the balance sheet of the company. Domino’s balance sheet is used for determining the book value (Tracy, 2011).

(Phx.corporate-ir.net. 2018). 

From the above statement

Total Assets = $836,753

Total Liabilities = (equity + liabilities) – equity

(-$2,735,384 + $3,572,137) – (-$2,735,384)

= $3,572,137

Book value = Total assets – Total Liabilities

$836,753 – $3,572,137 = -$2,735,384

The Book value is equal to the shareholder’s equity.

As it is said that, the figure of company’s balance sheet does not always shows the true picture of its financial position. So in order to avoid such risk, market value method is used to calculate value per share (Fried, Shapiro and DeSchriver, 2008).

Market value = stock price*shares outstanding

= 188.5*47,677,834

= $8,987,271,709

As a result:

15% of the Book value = -$2,735,384*15% = -$410301

15% of the market value = $8,987,271,709*15% = $1,348,091

From the above calculation, it is noticed that there is a great difference between the valuation methods. The market value of Domino’s is greater than its book value. Reason being the increasing net profits earned by the company. It is said that generally, all the profitable companies has high market value of their share than their book value. In the books of Domino’s, equity is been recorded as negative which makes the book value per share negative. So, if Pizza Hut wants buy 15% of Domino’s shares, it has to pay the amount equal to the market value.

Investment Advice

Looking at the profitability analysis done for Domino’s Pizza Inc., it will be advisable to the relative not to invest in company’s shares as the company does not have enough earnings to offer returns to its shareholders. This is due to the negative value of equity. However, Domino’s has made profit in the past years, but the company has negative ROE and high debt. This implies of high financial risk, which a person having an age of 85 years, would like to avoid it on priority basis. As it is the only condition of the relative that he is looking for the minimum risk and maximum returns investment, so it will be better for him, not to purchase the share of the company, until and unless he is not ready to take risk.  

Conclusion

The whole financial analysis of Domino’s Inc. shows that to measure the financial performance, ratio analysis is the best tool for that. Comparison with the main competitor Pizza Hut reflects the fact that domino’s has a low financial performance as compare to its competitor. Apart from good profits, Earnings per share and liquidity position, Domino’s Inc. is lacking behind from its competitor, in terms of financial strength and offering returns to shareholders. As it is clear that it has negative value of equity, which makes its ROE and Debt equity ratio negative. It also hampers its growth and success. So, overall it can be said that, if Domino’s make new stock offerings it can improve it debt and equity position. But as of now, the company is not performing will in both the terms.

References

Biz.dominos.com. (2018). What we’re about. [Online] Available at: https://biz.dominos.com/web/public/about [Accessed 25 March 2018].

Bragg, S. M. (2012). Financial analysis: a controller’s guide. New Jersey: John Wiley & Sons

Buckland, R., & Davis, E. W. (Eds.). (2016). Finance for growing enterprises. New York: Routledge.

Financials.morningstar.com. (2018). Income Statement for Domino’s Pizza Inc. (DPZ) from Morningstar.com. [online] Available at: https://financials.morningstar.com/income-statement/is.html?t=DPZ&region=usa&culture=en-US [Accessed 25 March 2018].

Fried, G., Shapiro, S.J. and DeSchriver, T.D., (2008). Sport finance. 2nd ed. USA: Human Kinetics.

Hussey, R. (2011). Fundamentals of international financial accounting and reporting. Singapore: World Scientific Publishing Co Inc.

Jenter, D., & Lewellen, K. (2015). CEO preferences and acquisitions. The Journal of Finance, 70(6), 2813-2852.

Lee, A. C., Lee, J. C., & Lee, C. F. (2009). Financial analysis, planning and forecasting: Theory and application. Singapore: World Scientific Publishing Co Inc.

Periasamy, P. (2009). Financial Management. 2nd Ed. New Delhi: Tata McGraw-Hill Education Pvt. Ltd.

Phx.corporate-ir.net. (2018). Domino’s Pizza® Announces Fourth Quarter and Fiscal 2017 Financial Results. [Online] Available at: https://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9Njg4ODI3fENoaWxkSUQ9Mzk5MTQxfFR5cGU9MQ==&t=1 [Accessed 25 March 2018].

Research, Z. (2018). Why Is Domino’s Pizza (DPZ) Up 4.6% Since Its Last Earnings Report? [Online] Available at: https://finance.yahoo.com/news/why-domino-apos-pizza-dpz-125112293.html [Accessed 25 March 2018].

Saleem, Q., & Rehman, R. U. (2011). Impacts of liquidity ratios on profitability. Interdisciplinary Journal of Research in Business, 1(7), 95-98.

Tracy, J.A., (2011). Accounting for Dummies. Hoboken: John Wiley & Sons.

Vogel, H. L. (2014). Entertainment industry economics: A guide for financial analysis. 9^th ed. USA: Cambridge University Press.