Strong Sales Dominate Domino’s Outlook

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

Momentum continues for Domino's Pizza, whose technology stands to benefit from continued growth in digital sales and the upcoming FIFA World Cup.

-Competitive intensity seen easing despite expansion of aggregators
-Germany, France at the forefront of growth targets in Europe
-Franchising inquiry a small short-term risk
 

By Eva Brocklehurst

Domino's Pizza Enterprises ((DMP)) has sustained momentum in online sales in Australia, which is significant because digital orders account for around 70% of its Australasian sales.

From tracking the company's app rankings and share of downloads, UBS concludes that the growth implied in guidance for the second half may not be all that optimistic. While the company's app ranking fell in Europe recently, where digital accounts for over 40% of sales, the rate of decline was consistent with the first half.

Given the latest app download study and the upcoming FIFA World Cup in Russia, UBS is increasingly confident in the outlook. Domino's Pizza has guided to 20% FY18 net profit growth, implying 33% growth in the second half, and the broker believes the company can grow its share of the Australian takeaway market to 6.2% by FY25, from 5.4% currently.

While there is a large opportunity for aggregators, they only compete across 10% of the takeaway market and UBS observes competitive intensity has eased in the second half ,despite the ramp-up in marketing and the expansion of coverage by aggregators.

The broker also suspects the market has not fully appreciated the challenges that face aggregators, such as coverage and value on offer.

UBS concedes the share price has risen 35% over the last three months despite little change to consensus estimates. Yet, a Buy rating is maintained, with a view that the medium term upside exists to market expectations if the company can achieve its long-term targets.

Europe

Europe remains the key opportunity for the business, although aggregators have eroded much of the company's historical competitive advantage. Hence, while acknowledging the risks around profit growth have increased, UBS assesses that its valuation incorporates the risks.

The broker estimates operating earnings margins in Europe can increase to 25% by FY21. Germany and France are likely to be at the forefront of growth targets as, combined, they are expected to drive 80% of incremental store growth in Europe.

Macquarie recently upgraded the stock to Outperform from Neutral. The broker considers the downside risks to guidance in the Australasian franchising business have lessened, while the outlook for Europe over the medium term has improved. The base is now in place in Europe for scale benefits.

The broker concludes that ,while full year guidance requires a very strong second quarter, the World Cup remains a positive catalyst. The business may longer deliver the growth rates of previous years but also no longer needs to, following a meaningful de-rating in valuation.

Macquarie considers the FY19 P/E ratio of 25x provides the valuation support necessary for a business expected to grow in excess of double digits per annum.

Despite believing that hitting 20% net profit growth in FY18 is still a tall order, Morgans believes any miss will be modest and has upgraded the stock to Add from Hold. The broker believes the company capable of delivering around 15% net profit growth per annum over the next 3-5 years.

Franchise Inquiry

The Senate inquiry into franchising in Australia may present a risk but, as Citi notes, submissions so far emphasise industry-wide issues rather than anything specific to Domino's Pizza.

Compliance costs may rise and store expansion may become more challenging but, in the end, Domino's Pizza has a very good digital platform and superior sales productivity, which validates its business model, in the broker's opinion.

The franchise inquiry is a short-term risk but Morgans agrees, having viewed the terms of reference, the company's submission and that of one franchisee, that any risks should be contained, and there is more negative implications for competitors in the industry, which should potentially benefit Domino's Pizza in the medium to longer term.

The broker believes the company is also unlikely to launch into any new category/territory without there being material accretion on offer and this creates an upside risk catalyst. Morgans believes the trading multiple is not out of place for what is still a growth stock.

There are four Buy ratings, three Hold and one Sell (Deutsche Bank) on FNArena's database. The consensus target is $48.64, suggesting -5.9% downside to the last share price. Targets range from $36.00 (Deutsche Bank) to $57.50 (UBS).

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