James Gruber: Johannes, thanks for joining us.

Johannes Faul: Thanks for having me.

Gruber: We've got you in today to talk about Domino's Pizza (ASX:DMP). Investors have had a wild ride with the stock this year. Some people are familiar with the brand but probably less so with the company itself. Can you describe Domino's business model. 

Faul: Yeah, absolutely. So, Domino's has very long-term master franchise agreements with the franchisors in the U.S., which means it's effectively the franchisor in the jurisdictions in which it operates. That system works in the way that Domino's franchisees pay a royalty based on their top-line sales to Domino's Enterprises. So, Domino's itself is mainly concerned about driving top-line growth within its network, within its multiple countries it operates in. So, that's a key concern. At the same time, obviously, Domino's wants to grow the store network quite dramatically over the next 10 years. And that means it has to have incentives in place or make it appealing for its franchisees to open up more stores or new franchisees to join that business. So, again, Domino's wants top-line growth, the franchisees like to see the bottom-line grow, their profit grow. And that's something that needs to be managed and that's what Domino's has been managing really well for most of the last decade.

Gruber: Okay. Earnings downgrades have led to a sharp fall in the share price in the first half of the year at least. Can you describe to us what led to those downgrades?

Faul: Yeah. So, Domino's has gone through a bit of a rough patch recently, and that really was driven by extraordinary inflation, not just in the ingredients to make the pizza, but also in wages, which makes the food the key cost for the stores. And not only has inflation been very high, it's also ratcheted up very quickly, which meant Domino's had to react very quickly with their price adjustments, and they got it wrong, which impacted demand for the pizzas.

Gruber: I suppose a lot depends on the health of the franchisees then, if it's a franchisee-led model. Is Domino's still a compelling offer for those franchisees?

Faul: Yeah, absolutely. In our view, it is. So, what it ensures is basically it's like a profit-sharing agreement. It has to ensure that the franchisees remain profitable and are incentivized to open up new stores, which then drives top-line growth for Domino's. So, Domino's has a very strong interest in the financial health of its franchisees and to maintain that. So, we do believe that it's still very appealing for franchisees to join the overall network, Domino's network.

Gruber: Are we through the worst then Domino's?

Faul: Well, Domino's is a growth stock, and I would say most growth stocks go through ups and downs and road bumps. So, no growth trajectory, even though the market might model that way and envisage that way is rarely a straight line. It has been volatile to your point. Is the worst behind it? We would say for now, yes. Will it remain more like a volatile stock in the earnings sense? Yes, but I think it's really important for investors to remember the long-term trajectory that Domino's has, and it has a massive store pipeline that we think is achievable. So, what really matters, in our view, is Domino's, are they going to hit those long-term targets, yes or no? That drives the valuation, that drives intrinsic value of this stock. Now, will the road there be a smooth one? Probably not. One key thing was shuttering unprofitable stores. So, that's one step that they've done that can instantly basically bring back profitability of existing store network because you're lifting the average.

Gruber: What's your fair value for the stock and what are the assumptions behind that?

Faul: Yeah. So, the fair value is $68 per share, which basically means there's a lot of upside, in our opinion, in its current share prices. Now, what underpins that, as I said earlier, was significant store growth in Europe and Japan, so in their key overseas markets. And as I say, the history that Domino's has, and even under current management, has been a history of success. So, Domino's has been taking market share for many, many years in the domiciles in which it operates, not just from independently-owned quick service restaurants but also compared to other chains.

Gruber: One pushback might be that Domino's tried to raise prices recently and that didn't quite stack up with customers. Does that make it a price taker rather than a price maker? Is that fair or not?

Faul: I would say that it's important for any retailer, any shop to get that price point right. Domino's has been very successful in getting that right in the past. As I said, the reason why it went wrong was it had to move very quickly without being able to test its pricing strategy for smaller population of stores and the like and then just slowly roll that out and see what works, what doesn't work. In this instance, wage cost inflation was such that – the inflation in food ingredients was that dramatic that they had to move quickly. They made a judgment call. They got that wrong, unfortunately. I would not say that the brand is in any way weaker because of that. In our opinion, a great brand like Domino's, the key to that is really the standard of quality. So, for a consumer to know every single time they go to Domino's, they will get a certain value for their money, a certain quality pizza and it will be the same over and over and over again, no matter where they are and which day of the week it is, it's always the same. So, that's the strength in our opinion of a brand and Domino's has that very, very strong brand. Inflation in food ingredients is coming off and while wages are still lifting, it's not as dramatic overseas as it was over the past 12 to 18 months.