Australia | Nov 08 2016
This story features DOMINO'S PIZZA ENTERPRISES LIMITED. For more info SHARE ANALYSIS: DMP
Domino's Pizza impressed most brokers with its AGM update, revising up long-term margin targets and earnings growth guidance.
-Persistent strong growth in Australasia a signal for success in Europe as digital platforms take hold
-New menu launched to capitalise on $700m milkshake/smoothie market in Australia
-Limited tolerance for any performance that does not keep up with market expectations
By Eva Brocklehurst
Domino’s Pizza Enterprises ((DMP)) impressed most brokers at its AGM indicating it has taken share in its category, with very strong sales and earnings growth persisting in Australasia.
The company has raised its guidance for operating earnings growth in FY17 to 30% from 25%, while its underlying profit guidance is unchanged at 30%. Domino's has increased its long-term margin and store network targets. Earnings margins in Australasia are now targeted for 45% within six years and in Europe for 25% within five years. The 2025 store target is increased to 4650, with 2600 envisaged for Europe, from the current store count of 2022.
Ord Minnett notes multiple growth drivers are being enabled by technology and product innovation, but the stock's valuation is elevated. This is key to the broker's Hold rating as earnings expectations are already high, leaving limited room for error, and there is reduced tolerance for any performance that does not materially exceed market expectations rather than Domino's guidance.
Deutsche Bank found the update more mixed, noting sales in Europe have slowed while Japan has improved just slightly, and attributes the very strong growth in sales in Australasia in the first 16 weeks of FY17 to the success of the new menu. Yet, the absence of an upgrade to profit guidance disappointed Deutsche Bank.
The broker is also more cautious about the expectations for growth in margins, believing wage pressures across the system will temper expansion. Still, Deutsche Bank expects sales growth will be strong and envisages considerable opportunities for rolling out new stores and efficiencies, particularly in Germany. Despite the strong momentum, risks to system profitability from rising wage costs means the broker maintains a Hold rating.
Morgans has fewer concerns, sticking with its Add rating. In a market devoid of much top line growth Domino's Pizza delivers in spades, the broker asserts. The most bullish aspect, in the broker's view, is the upgrade to long-term earnings margin targets in Australasia and Europe. The broker suspects unchanged net profit guidance was partially due to a higher tax rate being expected in FY17.
The persistence of strong growth in Australasia is expected to bode well for Europe and Japan as these territories start to benefit from digital platforms. The conversion of all Joey's Pizza stores is expected by the end of 2017 and Pizza Sprint is expected to be completed by FY17. Phase one of the new menu has been launched, which includes thick-shakes and ice cream. These items, to be rolled out fully in Australasia by July 2017, will attempt to capitalise on what Morgans calculates is a $700m milkshake/smoothie market in Australia.
The stock continues to be favoured by Morgan Stanley, which welcomes the update and believes this is only the start of the upgrade cycle. Long-term margin upgrades carry more significance than higher postulated earnings, the broker believes, and Australasia forms a blueprint for other regions, especially Europe given similar consumption patterns, competitive landscape and online propensity.
The broker believes Europe will develop at a faster rate because it is rolling out already-proven projects that have been optimised, rather than as in Australia where the company was a pioneer. The broker is also not concerned about the recent slowdown in Europe, where same-store sales growth has slowed to just over 3% in the past 11 weeks of FY17 from over 5.8% in the first five weeks. The unusually warm late summer could have impacted the outcome as much as 4-5%, the broker believes.
Macquarie observes the company is going from strength to strength in Australasia. The collapse of Eagle Boys Pizza in July this year probably provided the tailwind for the stronger-than-expected growth in the first 16 weeks of FY17. The collapse also provides an opportunity for the new owners of Pizza Hut in Australia, which will be looking to pick up a number of the stores.
While a reinvigorated competitor with deeper pockets may present a potential risk to Domino's Pizza, Macquarie expects Domino's investment in technology will help mitigate increased competition. The broker acknowledges the enterprise bargaining agreements currently in train will lead to a material increase in costs but suspects these will be largely incurred by franchisees.
Domino's Pizza expects the impact of wage rises to be absorbed by the technology it has introduced over the last two years. The company continues to invest in further growth and expects to continue rolling out new menus, and new stores (175-195 forecast in FY17).
Goldman Sachs envisages the company's leading online/digital capability and operational excellence will entrench its competitive edge and drive market share and support growth in new markets but believes these positives are largely factored into the stock. The broker, not one of the eight monitored daily on the FNArena database, retains a Neutral rating.
There are three Buy ratings and three Hold on the database. The consensus target is $75.23, suggesting 7.2% upside to the last share price. This compares with $77 ahead of the update. Targets range from $56 (UBS) to $95 (Morgan Stanley).
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