Business Strategy and Outlook:
The coronavirus catalyzed sweeping changes across the restaurant industry, with operators scrambling to provide delivery-integration, build out e-commerce, and pivot to digital-driven models. For Domino’s, save for the firm’s rollout of contactless car-side carryout, very little changed. The operator’s historical investments in “anyware” ordering, a best-in-class e-commerce interface, and a mix that skewed toward delivery (55%) before the pandemic propelled global systemwide sales growth of 20%, despite the global food-service market remaining 11% below pre-pandemic levels at
the end of 2021, per our calculations and Euromonitor data.
Domino’s 2020 results strongly validated management’s strategies (automation of core processes, a focus on volume-driven traffic growth, shrinking service radii, and transparent delivery pricing), and encouraged by their relevance looking beyond the 2020 and 2021. Moving forward, the biggest challenges facing the firm are likely to be the democratization of delivery services (expanding consumer optionality and increasing price sensitivity as groceries and convenience stores enter the mix) and input cost inflation, both of which are at least partially addressed by current strategies. While peers have turned to menu diversification and quality to carve out a niche, Domino’s commitment to value and convenience as disciplined, doubling down on core competencies. Menu diversification is risky, with no guarantee that operators can provide competitive products, while adding stock-keeping units and operational risk. Minimizing delivery times and emphasizing the higher-margin carryout business through fortressing, while maintaining strong value positioning should allow Domino’s to effectively compete in a world where expanded consumer choice demands quality, convenience, and competitive pricing.
Financial Strength:
Domino’s remains in good financial health, with a steady stream of royalty receipts handily covering interest obligations throughout the explicit forecast. While forecast 5.9 times debt/EBITDA at the end of 2021 (on the upper end of management’s 3-6 times targeted range) appears high at first blush, it is consistent with other heavily franchised operators in our coverage (Restaurant Brands International sports 5-6 times, while Yum Brands targets 5), and debt service represents a manageable average annual outlay of 26.5% of operating income through 2026. Further, the projected free cash flow conversion (or cash flow to the firm as a percentage of net revenue) of 14% over the same period offers ample flexibility to channel capital toward its most efficient use- whether new unit growth, software development, store remodeling, or shareholder distributions.
With restaurants often featuring negative working capital, attributable to longer-dated payables and a cash-focused business model, the solvency metrics as a more appropriate evaluation of operator’s financial health. An average EBITDA coverage ratio of 4.1 times through 2026, which appears sound. An effective interest rate of just 3.8% in 2021 corroborates this view, with Domino’s recent issues hovering around investment-grade breakpoints (as they are secured by future royalties and intellectual property). The firm’s debt maturities are adequately spaced out, with a negligible amount of principal coming due over the next three years. The firm relies on approximately biannual recapitalization transactions to pay down maturing issues, repurchase shares, and maintain leverage targets (with the intention of minimizing the firm’s weighted average cost of capital), with the most recent occurring in April 2021. Dominos also maintains a $200 million variable note funding facility, of which $155.8 million was available as of Dec. 31, 2021.
Bulls Say:
- Category-leading margins and a cohesive franchise network will continue to drive unit growth outperformance for Domino’s.
- The firm’s fortressing strategy allows it to capitalize on core competencies (price and convenience), cementing its leading role in the U.S. QSR pizza market.
- Master franchise relationships continue to push impressive unit growth in underpenetrated markets like Latin America, India, and China, which offer substantial space for greenfield development.
Company Profile:
Domino’s Pizza is a restaurant operator and franchiser with nearly 18,850 stores across more than 90 international markets. The firm generates revenue through the sales of pizza, wings, salads, and sandwiches at company-owned stores, royalty and marketing contributions from franchise-operated stores, and its network of 26 domestic (and five Canadian) dough manufacturing and supply chain facilities, which centralize purchasing, preparation, and last-mile delivery for the firm’s U.S. and Canadian restaurants. With roughly $17.7 billion in 2021 system sales, Domino’s is the largest player in the global pizza market, ahead of Pizza Hut, Papa John’s, and Little Caesars.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Business Strategy and Outlook
It is alleged InterContinental to retain its brand intangible asset (a source of its narrow moat rating) and expand room share in the hotel industry in the next decade. Renovated and newer brands supporting a favorable next-generation traveler position as well as its industry-leading loyalty program will drive this growth. The company currently has a mid-single-digit percentage share of global hotel rooms and 11% share of all industry pipeline rooms. It is seen its total room growth averaging 3%-4% over the next decade, above the 1.8% supply increase is projected for the U.S. industry.
With 99% of rooms managed or franchised, InterContinental has an attractive recurring-fee business model with high returns on invested capital and significant switching costs (a second moat source) for property owners, as managed and franchised hotels have low fixed costs and capital requirements, and contracts lasting 20-30 years have meaningful cancellation costs for owners.
It is anticipated InterContinental’s brand and switching cost advantage to strengthen, driven by new hotel brands, renovation of existing properties, technology integration, and a leading loyalty program, which all drive developer and traveler demand for the company. InterContinental has added six brands since 2016; it now has 16 in total. InterContinental announced in August 2021 a new luxury brand, with details to be provided soon. Additionally, the company announced a midscale concept in June 2017, Avid, which the company sees as addressing an underserved $20 billion market with 14 million guests, under a normal demand environment. Also, InterContinental has recently renovated its Crowne Plaza (13% of total room base) and Holiday Inn/Holiday Inn Express (62%) properties, which will support its brand advantage. Beyond this, the firm has over 100 million loyalty members, providing an immediate demand channel for third-party hotel owners joining its brand.
Financial Strength
InterContinental’s financial health remains good, despite COVID-19 challenges. InterContinental entered 2020 with net debt/EBITDA of 2.5 times, and its asset-light business model allows the company to operate with low fixed costs and stable unit growth, which led to $584 million in cash flow generation in 2021. During 2020, InterContinental took action to increase its liquidity profile, including suspending dividends and deferring discretionary capital expenditures. Also, the company tapped $425 million of its $1.3 billion credit facility, which has since been repaid. As a result, InterContinental has enough liquidity to operate at near zero revenue into 2023. It is likely banking partners would work to provide InterContinental liquidity as needed, given that the company holds a brand advantage, which will drive healthy cash flow as travel demand returns. InterContinental’s EBIT/interest coverage ratio of 5.4 times for 2019 was healthy, and it is held for it to average 9.1 times over the next five years after temporarily dipping to 3.4 times in 2021. It is projected the company generates about $2.3 billion in free cash flow (operating cash flow minus capital expenditures) during 2022-26, which it uses to pay down debt, distribute dividends, and repurchase shares (with the last two starting in 2022).
Bulls Say’s
- InterContinental’s current mid-single-digit percentage of hotel industry room share is set to increase as the company controls 11% of the rooms in the global hotel industry pipeline.
- InterContinental is well positioned to benefit from the increasing presence of the next-generation traveler though emerging lifestyle brands Kimpton, Avid, Even, Hotel Indigo, Hualuxe, and Voco.
- InterContinental has a high exposure to recurring managed and franchised fees (around 95% of total operating income), which have high switching costs and generate strong ROIC.
Company Profile
InterContinental Hotels Group operates 880,000 rooms across 16 brands addressing the midscale through luxury segments. Holiday Inn and Holiday Inn Express constitute the largest brand, while Hotel Indigo, Even, Hualuxe, Kimpton, and Voco are newer lifestyle brands experiencing strong demand. The company launched a midscale brand, Avid, in summer 2017 and closed on a 51% stake in Regent Hotels in July 2018. It acquired Six Senses in February 2019. Managed and franchised represent 99% of total rooms. As of Dec. 31, 2021, the Americas represents 57% of total rooms, with Greater China accounting for 18%; Europe, Asia, the Middle East, and Africa make up 25%.
(Source: MorningStar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Business Strategy and Outlook
JD.com has emerged as a leading disruptive force in China’s retail industry by offering authentic products online at competitive prices with speedy and high-quality delivery service. JD’s mobile shopping market share has increased from 21% in 2016 to 27% in 2020 on our estimate. JD adopted an asset-heavy model with self-owned inventory and self-built logistics, while Alibaba has more of an asset-light model.
JD is a long-term margin expansion story driven by increasing scale from JD direct sales and marketplace, partially offset by the push into JD logistics in the medium term. JD is the largest retailer in China by revenue. Among listed Chinese peers, JD’s net product revenue in 2020 was two to three times higher than for Suning, the second-largest listed retailer. JD’s increasing scale in each category will allow it to garner bargaining power toward the suppliers and volume-based rebates. Since 2016, JD no longer fully reinvests its gains from improving scale and is committed to delivering annual margin expansion in the long run. Gross margin improved yearly from 5.5% in 2011 to 15.2% in 2016, and following the consolidation of JD Finance in second-quarter 2017, gross margin improved year over year from 13.7% in 2016 to 14.6% in 2020.
In the medium term, it is likely to see the investment into community group purchase, JD logistics and the supermarket category will hold back some of the margin gains. JD is unlikely to have non-GAAP net margin increase in 2021. Starting in April 2017, the logistics business became an independent business unit that will open its services to third parties. Management is squarely focused on gaining market share instead of profitability at this point, and to do so, it has invested heavily in supply chain management, integrated warehouse, and delivery services to penetrate into less developed areas. As the logistics business gains scale and reaches higher capacity utilization, gross profit margin improvement can be seen. Management believes it is not time to turn profitable in the supermarket category in order to be a category leader in China.
Financial Strength
JD.com had a net cash position of CNY 135 billion at the end of 2020. Its free cash flow to the firm has continued to generate positive FCFF at CNY 8.1 billion in 2020. JD has not paid dividends.JD.com has invested heavily in fulfilment infrastructure and technology in recent years, leading to concerns about its free cash flow profile and margin improvement story. It is held management will put more emphasis on growing revenue per user, expansion into lower-tier cities and the businesses’ profitability. Therefore, JD will not invest in new areas as aggressively as before, so it is likely JD will be able to maintain positive non-GAAP net margin versus being unprofitable before. its financial strength will improve in future. Most of the initial investments in the third-party logistics business have been carried out, and utilization of the warehouses has picked up. Its technology team is already in place without the need to add substantial headcounts. JD will also be cautious in its investment in the group-buying business and new retail, given a profitable business model has not been established in the market. JD has tried to improve its asset-heavy model by transferring a portfolio of warehouses to establish a CNY 10.9 billion logistics property core fund in partnership with the sovereign wealth fund of Singapore, GIC. JD will own 20% of the fund, lease back the logistics facilities and receive management fees for managing the facilities. The deal will be completed in phases with the majority of them completed in 2019.
Bulls Say’s
- JD.com’s nationwide distribution network and fulfilment capacity will be extremely difficult for competitors to replicate.
- The partnership with Tencent could allow JD.com to gain significant user traffic from Tencent’s dominant social-networking products in China.
- JD is now the largest supermarket in China, the high frequency FMCG categories have attracted new customers from less developed areas and can drive purchase of other categories.
Company Profile
JD.com is China’s second-largest e-commerce company after Alibaba in terms of transaction volume, offering a wide selection of authentic products at competitive prices, with speedy and reliable delivery. The company has built its own nationwide fulfilment infrastructure and last-mile delivery network, staffed by its own employees, which supports both its online direct sales, its online marketplace and omnichannel businesses. JD.com launched its online marketplace business in 2010.
(Source: MorningStar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Investment Thesis
- Experienced management team and senior staff with a track record of delivering earnings growth.
- Strong balance sheet with little leverage.
- Strong presence and brands in the Australian aftermarket segment.
- Growing presence in Europe and Middle East and potential to grow Exports.
- Growth via acquisitions
- Current trading multiples adequately price in the near-term growth opportunities.
Key Risks
- Higher than expected sales growth rates.
- Any delays or interruptions in production, especially in Thailand which happens on an annual basis.
- Increased competition in the Australian Aftermarket especially with competitors’ tendency to replicate ARB products.
- Slowing down of demand from OEMs.
- Poor execution of R&D.
- Currency exposure
1H22 result highlights
Relative to the pcp:
- Sales of $359m, up +26.5%, underpinned by solid customer demand across all segments. Sales Margin was maintained.
- Profit after tax of $68.9m, and NPAT of $92.0m, were both up +27.6% relative to the pcp.
- The Board declared an interim fully franked dividend of 39.0cps compared with 29.0cps fully franked last year. Dividend payout ratio of 46% was higher than the 43% ratio in the pcp.
- Net cash provided by operating activities of $28.6m in 1H22, was driven by the profit after tax of $68.9m, offset by higher inventory holdings of $40.5m, as ARB sought to increase inventories in a challenging supply chain environment to facilitate continued sales growth.
- ARB retained a cash balance of $58.3m, a decrease of $26.4m from the June 2021 financial year end mainly due to expansionary capital purchases of PP&E for $27.0m and dividends paid to shareholders in October 2021 of $25.4m.
Company Profile
ARB Corporation Ltd (ARB) designs, manufactures, distributes, and sells 4-wheel drive vehicle accessories and light metal engineering works. It is predominantly based in Australia but also has presence in the US, Thailand, Middle East, and Europe. There are currently 61 ARB stores across Australia for aftermarket sales.
(Source: Banyantree)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Business Strategy and Outlook
As a result of the acquisition of the legacy Caesars business by Eldorado (closed July 2020), we estimate Caesars holds more than a 10% revenue share of the domestic casino gaming market; this represents around 100% of the company’s total EBITDA. Caesars has realized over $1 billion in combined revenue and cost synergies from its merger with Eldorado, representing around a 30% increase to pro forma 2019 EBITDAR. Despite this successful acquisition record, Morningstar analysts don’t believe Las Vegas and other U.S. gaming regions contribute to a moat for Caesars. U.S. gaming demand is lower than in Asian regions like Macao and Singapore, where the propensity to gamble is much higher. Also, the 1,000 commercial and tribal casinos in the U.S. serve a total population of 330 million, well in excess of the 41 and 2 casinos found in Macao and Singapore, respectively, with Chinese and Singaporean populations of 1.4 billion and 5.9 million, respectively. Further, supply growth in U.S. gaming is increasing in 2021-23, with two resorts opening in Las Vegas that add a mid-single-digit percentage to market room supply. This compares with negligible additions in either Macao or Singapore, where we see no additional licenses for the foreseeable future.
That said, Caesars’ U.S. casinos are positioned to benefit from the multi-billion-dollar sports betting and iGaming market. Caesars plans to invest around $1 billion in its digital assets in the next few years, which supports Morningstar analysts forecast for about 8% of the company’s total revenue to be generated from this segment in 2026.
After reviewing Caesars’ fourth-quarter results, Morningstar analyst have decreased its fair value estimate to $108 per share from $113, driven by increased digital spend. Morningstar analyst’s valuation places a 10 times enterprise value/EBITDA multiple on analysts’ 2023 EBITDAR forecast. Drivers of forecast remain anchored in revenue and EBITDAR margins across the company’s Las Vegas and regional assets.
Financial Strength
Caesars’ debt levels are elevated. In 2019, excluding financial lease obligations, legacy Caesars’ debt/adjusted EBITDA measured a hefty 7.8 times, while legacy Eldorado came in at 3.7 times. Morningstar analysts see Caesars’ debt/adjusted EBITDA reaching 7.9 times in 2022 and then 6.4 times in 2023 as global leisure and travel market demand continue to recover from the pandemic, aided by company cost and revenue synergies that analysts estimate to total over $1 billion. Morningstar analysts expect the $7.5 billion in free cash flow in 2022-26 as focused on reducing debt levels and investing in the digital sports and iGaming markets, with share repurchases and dividends not occurring until 2025. Caesars has no meaningful debt maturity until 2024, when $4.8 billion is scheduled to come due.
Bull Says
- Caesars’ best-of-breed management stands to generate cost and revenue synergies from its merger with Eldorado.
- Caesars has the largest property (around 50 domestic casinos versus roughly 20 for MGM) and loyalty presence (65 million members versus MGM’s roughly high-30 million), which presents cross-selling opportunities.
- Morningstar analysts see Caesars’ domestic properties as well positioned to benefit from the $6.2 billion U.S. sports betting revenue opportunity in 2024.
Company Profile
Caesars Entertainment includes around 50 domestic gaming properties across Las Vegas (50% of 2021 EBITDAR before corporate and digital expenses) and regional (63%) markets. Additionally, the company hosts managed properties and digital assets, the latter of which produced material EBITDA losses in 2021. Caesars’ U.S. presence roughly doubled with the 2020 acquisition by Eldorado, which built its first casino in Reno, Nevada, in 1973 and expanded its presence through prior acquisitions to over 20 properties before merging with legacy Caesars. Caesars’ brands include Caesars, Harrah’s, Tropicana, Bally’s, Isle, and Flamingo. Also, the company owns the U.S. portion of William Hill (it plans to sell the international operation in early 2022), a digital sports betting platform.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Business Strategy & Outlook:
MetLife, like other life insurers, has its financial results tied to interest rates. It’s unlikely that interest rates will return to pre-financial-crisis levels, and MetLife has forecasted to face this headwind for the future. The returns of equity just shy of 10% over the next five years. MetLife has taken steps to simplify its business. In 2017, it spun off Brighthouse, its retail arm focused on variable annuities. MetLife also is divesting its property and casualty insurance (auto) business, which makes sense as there is minimal strategic benefit to having a small auto insurance business in its portfolio.
MetLife’s business is relatively undifferentiated. Whether sold individually or to employers, the pricing is the primary driver for MetLife’s customers. Given the relatively low fixed costs of an insurer’s income statement, this does not lend itself to MetLife having a competitive advantage. Some of MetLife’s entries into new markets (such as pet insurance and health savings accounts) are potentially more differentiated, but these are unlikely to be material in the near to medium term. In 2012, MetLife launched MetLife Investment Management, which currently manages $181 billion of institutional third-party client assets, a fraction of the $669 billion managed through the general account and a fraction of what some of its peers manage. Asset management is viewed as potentially moaty, but given the size of MetLife’s third-party asset management, it is viewed as material to the firm’s overall financial results.
Financial Strength:
The life insurance business model typically entails significant leverage and potentially exposes the industry to outlier capital market events and unanticipated actuarial changes. MetLife is not immune to these risks, and during the financial crisis, its returns on equity decreased. Overall, MetLife has generally been prudent, but the risks inherent to the industry should not be ignored.
Equity/assets (excluding separate accounts) was 11.6% at the end of 2021, higher than the 11.1% average since 2010. In Japan, MetLife’s solvency margin ratio was 911% (as of Sept. 30, 2021), well above the 200% threshold before corrective action would be required. The solvency margin ratio measures an insurer’s ability to pay out claims in unfavorable conditions.
Bulls Says:
- MetLife’s international operations, particularly Asia and Latin America, provide opportunities for growth.
- MetLife’s reorganization will lead to a more transparent entity that produces steadier cash flow.
- If interest rates were to rise, MetLife would benefit through higher reinvestment yields.
Company Profile:
MetLife–once a mutual company before the 2000 demutualization–is the largest life insurer in the U.S. by assets and provides a variety of insurance and financial services products. Outside the United States, MetLife operates in Japan and more than 40 countries in Latin America, Asia-Pacific, Europe, and the Middle East.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
Business Strategy & Outlook:
As the leader in electronic signatures and contract life cycle management software, DocuSign has a long runway for growth through viral adoption in greenfield opportunities. The existing customers adopting more use cases and expanding seats over time, and also moving to the Agreement Cloud platform. DocuSign’s vision is to modernize the contracting process by taking it from a disjointed and paper-based manual sequence of steps to an automated digital and collaborative system. The company has mastered the “sign” step of the process and has used it to build the Agreement Cloud around, but there’s more to DocuSign than just e-signatures. The Agreement Cloud is a platform that includes tools to help users prepare contracts using intuitive drag and drop forms, negotiate, e-sign using a variety of enhanced security and identification means, automate agreement workflows for satisfying contract elements post-execution, allow for payment collections, and centralize account management.
As use cases expand, it is expected that the current primary driver of growth, the e-signature solution, to continue to grow rapidly thanks to the company’s entrenched leadership position and the more unpenetrated market. Underlying the larger picture is that the company still offers free trials and self-service for pain-free test drives. There’s visibility of strong adoption in more than one million paid customers, with 88% involving a sales rep, and hundreds of customers already driving annual contract value in excess of $300,000 annually. In the meantime, net dollar retention rates have been strong, about 120%, which is very good and is in line with other self-service, viral adoption models in our coverage. Based on a bottom-up analysis, management estimates that DocuSign has a total addressable market of $50 billion, half of which is e-signatures alone, while Agreement Cloud is the next largest piece, with other services making up a smaller opportunity.
Financial Strengths:
DocuSign is a financially sound company with a solid balance sheet, improving margins, and rapidly growing revenue. Capital is generally allocated to growth efforts and acquisitions, with no dividends or buybacks on the horizon. As of fiscal 2022, DocuSign had $803 million in cash and marketable securities, compared with $718 million in long-term debt. The company generated non-GAAP EBITDA of $593 million in fiscal 2022, representing gross leverage of 1.2 times. DocuSign generated free cash margins of 15% in fiscal 2021 and 21% in fiscal 2022. It is expected that free cash flow margins to continue to expand during the next five years. The debt relates to convertible notes due in 2024. DocuSign can satisfy its obligations while continuing to fund normal operations.
The company has made a variety of relatively small acquisitions, including Seal, totaling in excess of $400 million over the last several years. Company view these as feature additions or product extensions that are additive to the company’s product development efforts. While it is acknowledge the timing and size of potential future acquisitions may vary, nonetheless model a modest level of acquisitions annually.
Bull Says:
- DocuSign is the market leader in e-signatures and is expanding to a broader contract life cycle management solution.
- The free trial, easier implementation, and rapid return on investment for DocuSign customers make for a compelling sales pitch. The company is also enjoying success moving upstream to larger customers.
- DocuSign’s market consists of considerably more greenfield space than is typical within software.
Company Profile:
DocuSign offers the Agreement Cloud, a broad cloud-based software suite that enables users to automate the agreement process and provide legally binding e-signatures from nearly any device. The company was founded in 2003 and completed its IPO in May 2018.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.