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Sky high margins prove franchising is a winner for Domino’s Pizza Group plc, Fevertree Drinks plc and InterContinental Hotels Group plc

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Franchising may have played its part in decimating local high street shops and spreading the worst of American food across the world, but investors should love the high margins and reliable revenue streams the system provides. Look no further than Domino’s (LSE: DOM) to see how beneficial franchising can be for owners and investors alike. In 2015, Domino’s UK and Ireland boasted operating margins of 24%, which is high for most sectors, and especially so in the highly competitive and traditionally low-margin restaurant industry.

Domino’s was this profitable because the vast majority of its 931 stores are franchised out, meaning reliable revenue from licensing agreements and sales of ingredients to individual stores. Underlying operating profits jumped a full 16% last year as 65 new stores were opened and like-for-like sales at existing locations rose an impressive 11.7%. The market can’t get enough of Domino’s continued growth and shares now trade at a pricey 26 times forward earnings. Still, if the company can build on consecutive years of double-digit earnings per share growth, even today’s price could be a long-term bargain.

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Long-term winner?

Next time you see a bottle of Fevertree (LSE: FEVR) tonic or lemonade at a grocery store, take a second to appreciate the impressive 29% operating margins the company makes on each bottle distributed. Fevertree can extract so much profit because it outsources the expensive and capital-intensive process of bottling and distributing to third parties. While this isn’t exactly a traditional franchise business model, it works in a similar fashion with management freed from overseeing the nitty gritty of low-margin business areas to focus on the bigger picture.

So far this has worked a charm as sales leapt 70% in the last full year and operating profits rose 113% in the same period. This growth doesn’t appear ready to slow any time soon as the company is pushing forward with rapid expansion plans and already brings in 65% of revenue from outside the UK. Last month’s trading update also brought good news with management revealing that sales were exceeding guidance and margins were also improving. While shares are valued very highly at 40 times forward earnings, Fevertree’s market dominance, high margins and growth potential all point towards a long-term winner in my eyes.

Strong strategy

Hotels have traditionally not been high margin businesses, but that’s why InterContinental Hotels Group (LSE: IHG), owner of the Holiday Inn and InterContinental brands, has moved to sell-off managed hotels to franchise partners. IHG now franchises out 84% of its hotels, which led to astounding operating margins of 83% in the last full year.

Of course, the company’s reliance on business and leisure travel means it’s still highly exposed to any slowdown in global economic growth no matter how far removed the group is from the day-to-day running of hotels. That said, very high margins, impressive geographic diversification, particularly in China, and a solid 2.6% yielding dividend makes IHG an impressive option to me.

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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Domino's Pizza. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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