Room to improve in 2006 at Pizza Hut and Domino's Pizza

July 24, 2006

High gas prices and a slowing economy combined to soften sales at the world's top two pizza chains in the first half of the year. But officials from both Pizza Hut and Domino's Pizza aren't blaming their 2006 struggles solely on outside influences. In recent investor conference calls, leaders of both companies found fault in products and programs that didn't generate expected returns, and both companies vowed to improve results as the year progresses.

This year has been especially tough for Pizza Hut. The 12,000-unit company delivered negative comparable-store sales in every month (July minus 7 percent, June minus 9 percent, May minus 7 percent, April minus 5 percent, March minus 1 percent, January minus 4 percent) except February, when comps rose just 1 percent.

During a July 20 investor conference call, David Novak, chairman of Yum! Brands, which owns Pizza Hut, touted the successes of sister brands Taco Bell and Kentucky Fried Chicken and added, "Pizza Hut is another story. The picture hasn't begun to change even as we have begun to lap weaker performance versus a year ago. Our sales are down, and sales are down for the category."

Novak traced some of Pizza Hut's woes to the company's position in the category. Its higher guest check average is driven by premium pizzas, which make for totals similar to those spent in casual dining restaurants. Casual dining, numerous restaurant analysts have said, is taking the hardest hits from higher gas prices because consumers are trading down to fast-casual and quick-service restaurants when eating out.


What's Important

It's not always fun being industry leaders, and Pizza Hut and Domino's Pizza can attest to that fact this year.

The world's top two pizza chains posted negative comparable-store sales in the first two quarters of 2006, and leaders at both say the slowing economy will make the second half tough as well.

Both chains said their new product pipelines are full through the end of the year and that they expect sales declines to reverse sooner than later.

while struggling, Pizza Hut remains strong, Novak insisted. The brand has a firm grip on its leadership of the category, and the company is developing a roadmap to recovery. "I can assure you we are putting a full-court press on making progress at Pizza Hut." Improvement, he said, should come in this year's fourth quarter.

When pressed by one analyst to forecast how Pizza Hut will accomplish a turnaround, Novak declined to offer details.

"We know this category is driven on a combination of product news, price value and improved operations," he said. "We're focused on all three of those, but I don't really want to go into all of those tactics. I can tell you we have done a lot of research to get at what the issues are."

Pizza Hut's problems aren't restricted to the United States. Sales continue to slip in already-struggling markets like Australia, where store counts have dwindled continually for some time and same-store sales fell 11 percent one quarter ago. The company announced in April it will sell its remaining stores in the state of Victoria to franchisees. The state is arguably Australia's toughest market, one dominated by independents and where Domino's has deep penetration.

The brand's struggles in the United Kingdom are ongoing as well. Slack sales have led Whitbred PLC, which owns a 50-percent share in the business there, to examine selling its Pizza Hut interest.

Pizza Hut is doing well, however, in China, where the chain has more than 200 "casual dining" units.

"We are in over 50 cities and clearly the undisputed leader in the casual dining category," Novak said. "We are meeting and even exceeding our expectations for this brand."

Novak said there are 31 "Pizza Hut Home Service" units operating in China and producing good unit economics. (Chinese families are slow to warm up to delivery because, traditionally, trust between restaurants and customers must be established in dine-in restaurants.)

"There is no doubt the home service market is emerging in China, and we will be there to capitalize on the opportunity," Novak said. "We ultimately have the potential for 2,000 Pizza Hut Casual Dining locations."

Resetting Domino's

After a strong 2005, leaders at Domino's Pizza knew topping

start quoteWe have plenty of bullets to fire in the second half. ... We've got a calendar set up in the second half of the year that's very strong.end quote

— David Brandon, Chairman, CEO
Domino's Pizza
those numbers this year would be a stiff challenge. They were right.

In the first quarter of 2006, domestic comps slid 3.8 percent versus an increase of 11.2 percent last year. In Q2 comps dropped 4.9 percent versus an increase of 6.9 percent the year prior.

Chairman and chief executive David Brandon said the company also didn't anticipate this year's slumping economy, but he didn't blame Domino's problems on it either.

"Our new products have simply not performed as well in national rollout mode as we experienced in our test market platforms staged back in 2005," Brandon told investors during a July 20 conference call. "We have a very promising pipeline of recently tested promotions and products. We believe they will resonate well with consumers."

Brandon said he isn't questioning Domino's product testing methods because they've borne predictable results in the past. Past differences between target-market rollouts and national rollouts were minimal until this year, when "we saw much greater variance ... and it was a negative variance."

Brandon returned to a familiar mantra of suggesting investors examine Domino's long-term performance as a sign of its steady performance rather than dwelling on short-term losses. Over the past five years, he said Domino's second quarter same-store sales averaged plus-8 percent, compared to Papa John's 4.3 percent increase and Pizza Hut's 4 percent drop.

When an analyst questioned whether Domino's reduced national marketing expenditures hurt results, Brandon said no and called the chain's spending plan "balanced across the year. We have plenty of bullets to fire in the second half. ... We've got a calendar set up in the second half of the year that's very strong."

Brandon said Domino's will widen its domestic position by building as many as 800 additional units in the coming years. He said national marketing dollars are being spent creating a buzz in areas where Domino's lacks a presence, and he wants that to change.

Domino's did not discuss its international results in detail, but said its nearly 2,000 stores outside the United States saw comps grow 5.7 percent for the second quarter. The increase marked the fiftieth straight quarterly increase for international same-store sales.

The company's outlets in the United Kingdom continued a long-unabated string of positive comps, and its Australia unit counts continue to grow as that franchise group expands to Europe. This month, Domino's Pizza Australia & New Zealand bought 155 corporate units in France, Belgium and the Netherlands for $11 million. The group believes it can add about 850 stores to those countries.

Brandon saluted No. 3 Papa John's for its continued comp-sales growth in 2006, and he assured analysts Domino's also will report positive results again sooner than later.

"When sales are a little bit harder to come by and we're comping up against tough numbers, it becomes a bit of a rallying cry" for the Domino's team, he said. "We all know we've got to get a little bit sharper and provide better service. We've got to take care of our customers because there aren't as many as we'd like to have, and we've got to work really hard in our local communities to make sure we're connected and maximizing our opportunities."

Topics: Domino's Pizza , Pizza Hut , Public Companies

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