Australia | Jul 07 2022
This story features DOMINO'S PIZZA ENTERPRISES LIMITED. For more info SHARE ANALYSIS: DMP
Brokers see upside from Domino’s new delivery fee and other levers to ward off inflation.
-Domino’s introduces a new service delivery fee
-Minimal demand destruction expected
-Morgan Stanley explains how inflation benefits
-Why it’s important to preserve franchisee margins
By Mark Woodruff
While franchisees of Domino’s Pizza Enterprises ((DMP)) have been facing considerable cost pressure via increased ingredient, energy and wage costs, there are several avenues to support franchisee margins.
Morgan Stanley cites the recent introduction of a 6% delivery fee across the Australian and New Zealand network as part justification for this view. To the extent that network profitability is maintained, the company is considered a beneficiary of inflation, given the majority of earnings derive from food margins and royalties.
In large part, the new fee enables the broker to leave FY23 earnings estimates unchanged, despite also factoring in higher inflation expectations for the company of 7.5%, up from 5.0%.
While the delivery fee is highly transparent at the point of checkout, Ord Minnett points out it doesn’t impact upon value messaging achieved via value bundles.
The analysts at Morgan Stanley agree and see only minimal demand destruction from the new fee. This is because the total cost of a Domino’s delivered pizza is -35% cheaper than the competition. Pizza Hut and Crust charge a flat $5.00 and $7.00 delivery fee, respectively. On a $30 basket size, Domino’s is estimated to be -12% cheaper on a total-order cost basis. In addition, it's thought price sensitive customers may avail themselves of the company’s pick-up service to avoid the surcharge.
However, there is potential for switching into supermarket-based alternatives, including frozen pizza and cooking at home, cautions Ord Minnett.
UBS cites a number of key advantages Domino’s has over competitors to manage inflation, including (part) hedging of key commodity costs. Food comprises 32% of the overall cost base for the company, with labour and mileage combined at around the same level.
Price increases are also occurring. Readers may have received a recent email offer for the most popular promotion of three delivered pizzas for $33, up from $30. Key price points, such as the value range pizzas at $5, remain in place, assures the broker.
Why is it important to preserve franchisee margins?
Preservation of franchisee margins decreases the likelihood of Domino’s having to offer support to the network via reductions in the food margin.
Morgan Stanley points out the benefit from a delivery fee flows directly through to franchisee margins, which is not the case for alternative promotion and pricing strategies.
Ord Minnett believes the fee is an important next step in improving franchisee unit economics across the network after the recent introduction of the $12m/year Ignite program.
The program is designed to improve franchisee economics around network expansion, including fortressing underpenetrated regions.
Fortressing is the concept of opening new stores within existing territories, explains Morgan Stanley. The practice shrinks delivery areas, improves delivery times/costs and leads to a better-quality product.
Morgan Stanley points out that around 55% of Domino’s Australian and New Zealand sales are delivery based, and all else being equal, the new delivery fee should increase domestic same store sales (SSS) growth by 3.3% and group SSS growth by 1%.
The broker also sees inflation as a catalyst for management to increase top-line growth through a combination of promotion ("more for more") and outright price increases.
In a recent research note, Jarden noted the relative outlook for Domino’s was improving, aided by its ability to manage inflation better than peers. The potential for margins from Japanese stores to surprise positively in FY23 was also stated.
The broker, not one of the seven brokers updated daily in the FNArena database, trimmed group store growth projections to reflect risks around potential new store delays due to supply chain and macroeconomic uncertainty. While the target price was reduced to $93 from $96, an Overweight rating was maintained.
The FNArena database has seven brokers ratings which include five Buy (or equivalent) ratings and two Neutral ratings. The average target price set by brokers of $91.90 suggests 23% upside to the latest share price.
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