Domino’s Serves Up Disappointing Outlook

This story features DOMINO'S PIZZA ENTERPRISES LIMITED. For more info SHARE ANALYSIS: DMP

Domino's Pizza has disappointed brokers with a weak FY17 result and conservative FY18 outlook. The company has also announced a debt-funded $300m buy-back.

-Signs of a recovery in Europe but Australasian slowdown expected to continue
-Calculating fair value an issue for brokers
-Is the buy-back appropriate?
 

By Eva Brocklehurst

Domino's Pizza Enterprises ((DMP)) has disappointed brokers, producing a soft FY17 result which missed expectations in several regions. Growth in FY18 is expected to be considerably lower than in previous years, yet still in the region of 20%. The company has also announced a debt-funded $300m buy-back of shares.

The main problem was in Europe with same-store sales well below guidance. Australasia and Japan also missed expectations. Cash conversion was weak and the result boosted by a $18.6m profit on store sales.

Deutsche Bank's estimates decline sharply over the forecast horizon, with downgrades across all segments. The broker felt the disappointment keenly as, in some cases such as same-store sales for Australasia, guidance had been upgraded multiple times throughout the year. The miss was exacerbated because there were meaningful profits on lumpy items such as equipment sales as well.

Morgan Stanley remains more positive although acknowledges the stock has taken a hit, as technical problems affected its digital roll-out and pour promotional planning led to a miss on earnings estimates.

The broker believes the European problems are likely to prove temporary, although the Australasian slowdown is inevitable and occurring sooner than expected, and the market will again look at the long-term opportunity. Morgan Stanley suspects 20% guidance for FY18 net profit growth is conservative, as it implies declining margins, considered highly unlikely given operating leverage.

The inability to surprise the market with better outcomes and the lack of success so far in Europe are likely to weigh on the share price, Ord Minnett asserts, despite the stock being an attractive growth business.

Stepping back from the significant reduction in the share price, the broker highlights the still-strong growth rates emanating from same-store sales and margin expansion. Ord Minnett awaits further evidence of success in Europe on a same-store sales and margin basis, which would then support the significant potential.

Valuation?

Despite the disappointment there were no ratings changes among brokers on the database. The key question several now pose is what is the right multiple for this business going forward. Looking at a basket of global peers, Morgans calculates the average forward 12 months price/earnings ratio is around 25x and the enterprise value/EBIT (operating earnings) is 16.6x. As a result, on this basis, Domino's Pizza would trade on 28x and 20.8x respectively.

Morgans retains a Hold rating and considers FY18 guidance is readily achievable via footprint and same-store sales growth as well as further margin expansion. Furthermore, realising 100% of earnings from Japan in FY18 makes the guidance conservative, in the broker's view.

Citi also poses the question regarding the right multiple for the stock. The broker's calculation of a fair price/earnings ratio is 23x, given the balance of risks. Hence, while expecting 22% growth in net profit in FY18, the broker considers the shares expensive. Sell retained.

Buy-Back

The main disappointment for Deutsche Bank was the buy-back. The broker cannot comprehend how buying back the shares, which generate 3-4% earnings yield, can ever be a sound use of shareholder funds and suspects it is a desperate move to prop up the share price.

Separately, CEO Don Meij intends to sell stock at the next trading window in order to meet financial obligations relating to his share of acquisition costs, taxation and a matrimonial settlement. This would be the second time he has sold stock and Deutsche Bank is vexed, as it is happening concurrently with the buy-back. The broker continues to believe this company is taking too much out of the profit pool and retains a Sell rating.

UBS agrees there was not a lot to like in the results. FY18 guidance implies around -11% downgrades to consensus and this is disappointing as the company had upgraded guidance at the first half results. The broker is also lukewarm on the buy-back, which is only modestly accretive and suggests near-term acquisitions are not imminent.

On the positive side, European same-store sales growth in the year to date is ahead of forecasts and medium-term margin targets have been reiterated. While it is easy to be caught up in a disappointing result, the broker believes the stock is still a high-quality, capital-light business with a proven track record and the market is undervaluing the longer-term European opportunity.

Nevertheless, the broker considers it unlikely the company will reach a 10% share of Australasian takeaway by 2025. This view reflects slowing growth in the online takeaway market and a faster take-up of third-party aggregators. UBS does not expect European margins will reach those of Australasia by FY21.

FNArena's database has two Buy ratings, two Hold and two Sell. The consensus target is $47.22, suggesting 12.9% upside to the last share price. This compares with $63.59 ahead of the results. Targets range from $38 (Deutsche Bank) to $60 (UBS).
 

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