Domino’s Painful Steps Yet To Convince All

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

Under a new CEO, Domino’s Pizza is moving swiftly to right-size its business through store closures while addressing further cost savings initiatives.

-Domino’s Pizza’s sales growth to date better than feared
-Plan to close 205 unprofitable stores
-Further cost efficiencies will be sought
-Debt ratio improvement ahead

By Greg Peel

Ahead of last Friday, Domino’s Pizza Enterprises ((DMP)) was the fourth most shorted stock on the ASX at 12.9%. The company now regularly pre-reports its results ahead of the official release, and on Friday guided to a better than feared interim result, with underlying profit in line with consensus.

A trading update for the first five weeks of FY25 showed group same-store sales up 4.3% compared to consensus of 2.6%. However, this was not the sole reason for what appeared to be a short squeeze on Friday as the stock shot up over 20%.

Analysts expect the first half result will show sales growth below 4.3% for the first seven weeks, given the Asian region benefited from the timing of Chinese New Year. Sales in the first five weeks rose 0.6% in A&NZ (consensus 2.5%), fell -4.2% in Asia (-2.2%) and rose 0.6% in Europe (-0.8%).

While France remains challenged, notes Petra Capital, Japan (plus other Asian markets) appears to be past its lows, Germany is rebounding, and A&NZ is holding up against strong comparable sales numbers from a year ago. For the first time in a long while, highlights Petra, there are now more markets showing positive trends versus negative.

The significant positive surprise accompanying the update was nevertheless the pace at which management, under a new CEO, has identified a recovery path for the portfolio.

Reassessing Japan

As part of the trading update, Domino’s announced $34.1m of annualised savings with more to come. Part of these savings ($15.5m in earnings) is attributed to the closure of 205 loss-making stores occurring in the June quarter. Of the 205, 172 (58 franchise and 114 corporate) will be in Japan.

This will reset Japan to around 770 stores, exiting sub-scale prefectures. The focus will be on prefectures in which Domino’s can leverage scale, brand strength, and operational efficiencies.

The company will incur a one-off impact of -$97.2m in FY25 for these closures (-$37.4m cash impact). Management said in the call it believes the store network has now been right-sized for future growth and doesn’t expect any future store closures.

Domino’s has also identified $18.6m of annualised savings associated with simplifying the network and the cost base and identifying opportunities to buy better and spend better in areas including food, packaging and technology, Morgans points out.

Given the review of the cost base is continuing, management has yet to determine both the size of the total savings pool and how it plans to balance how much of the savings will flow to its franchise network (to lift unit economics) versus its own bottom line.

At the FY24 result, on Morgans’ estimates, Domino’s needed to lift average sales per store by around 10% to achieve the desired three-year payback. The broker believes the right move is for any cost savings to be reinvested in the franchise network so that the three-year payback period is achieved sooner rather than later. Management plans to provide a more detailed update on its turnaround strategy at its Investor Day in the second half.

With cost savings to be realised following the refinement of the store network, Domino’s will use the benefits of its strategic initiatives to re-invest into the franchisees. Initially, Macquarie expects a greater portion of these savings to be allocated to the franchisee network to drive a meaningful recovery in sales and earnings momentum at the store level.

If successful in improving store performance, the initiatives will increase per store sales and support a return to network expansion, both positive to long-term earnings, Macquarie notes.

Will it work?

Domino’s in-line interim result was driven by cost management rather than same-store sales growth. A significant below-the-line expense of -$97.2m has been taken in FY25, but the company is now taking what Citi describes as the necessary but painful steps (unprofitable store closures, cost savings) to put itself in a position where it can invest more in its franchise network to increase franchisee profitability and attempt to accelerate store rollout.

However, it is still unclear to Citi whether the business can sustainably grow its top line in key high growth markets, such as Japan and France, which is required for longer term success and to prevent further downgrades. It is also unclear what impact the loss of scale from closures will have on sales and buying power.

The balance sheet is likely to be “topical,” Citi suggests, with leverage increasing and the company underwriting its interim dividend.

Citi has left its Neutral rating and $33.25 target price unchanged.

Morgans has raised its target to $32.70 from $30.70. Domino’s is taking the right approach in identifying cost savings to reinvest in its network, Morgans suggests, which should drive improvements in unit economics and hopefully in time lead to better shareholder returns. However, a Hold rating is retained for now given the broker wants more clarity on the long-term growth outlook of the business.

Macquarie sees risks as more balanced as Domino’s works through portfolio refinement and re-investment into the franchisee network. Hence an upgrade to Neutral from Underperform, and a significant target increase to $35.10 from $28.20.

In a brief update, Morgan Stanley suggests there is no impact to its investment thesis and retains an Overweight rating with an unchanged $40.00 target.

That leaves one Buy or equivalent rating and five Holds from brokers monitored daily by FNArena covering Domino’s Pizza. Ord Minnett (Hold) is nonetheless yet to respond to the trading update.

Targets range from $30.00 (Ord Minnett) to $40.00 (Morgan Stanley), for a consensus of $34.51 slightly below the current trading price.

Goldman Sachs has revised down its FY25/26/27 underlying earnings (EBIT) forecasts by -2%/-5%/-5%, factoring in updated network cost savings benefits associated with store closures from the June quarter. But Goldman expects FY25/26/27 earnings per share to increase by 3%/20%/18% as the company continues to improve its net debt leverage ratio.

Despite significant work ahead for the company, Goldman agrees with the strategic pivot to refocus on unit economics as a first step and is encouraged by the swift action of the new CEO. That said, comfort around same-store sales growth inflection to positive momentum, especially in Japan and France, will be most critical for the path forward, and the broker will focus on this in the first half results.

Goldman Sachs’ target falls to $38.30 from $40.20 with an unchanged Buy rating.

While Petra Capital recognises store rollout pace will remain slow and there remains more work to do to lift store metrics, this broker believes underlying trends on sales and costs are on an improving trajectory, and balance sheet debt leverage is also improving. Petra upgrades To Buy from Hold, raising its target to $40.00 from $32.00.

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