Domino’s Sales and Store Rollout Disappoint

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

While brokers express significant disappointment over lower store rollouts and sales by Domino's Pizza Enterprises, some positives are emerging.

-Brokers materially lower target prices for Domino's Pizza Enterprises
-Store rollouts, sales and costs all disappoint
-Management announces cost initiatives
-Is there risk of a debt covenant breach?

By Mark Woodruff

Brokers are becoming increasingly worried about the growth profile for Domino's Pizza Enterprises ((DMP)) following the release of yesterday’s FY23 trading update.

While management is planning to achieve substantial annualised cost savings, store openings will not meet FY23 or FY24 targets, and management flagged FY23 same store sales (SSS) growth remains below its medium-term outlook of 3-6% annual growth.

Domino’s is the largest franchisee outside of the US and holds the master franchise rights to the Domino’s brand and network in Australia, New Zealand, Belgium, France, The Netherlands, Japan, Germany, Luxembourg, Denmark and Taiwan.

Macquarie points out store rollout targets have been a key driver for Domino’s growth over the years, while the secondary driver has been same store sales.

The company’s store count target has been reduced by -150 stores, with the business removing its targets for the Danish business as it exits the market.

UBS notes SSS growth has been weak in FY23 as volumes fall in reaction to rapid price rises and higher delivery service fees, as Domino’s responded to unprecedented cost increases and earlier delays to price rises.

The way to improve SSS growth, suggest the analysts, is for management to improve execution of price and product offers to engage lapsed customers, who now prefer either supermarket pizza or other quick service restaurant (QSR) offerings.

As a result of these changing preferences, average customer frequency has blown out to six weeks from four.

In trying to mitigate inflation through the imposition of service fees, Morgans believes the company used the wrong approach, which was further exacerbated by a global shift away from delivery and by relentless input cost inflation.

UBS is disappointed execution has not already improved and now assumes lower rates of near-term organic store growth, lower long-term rates of SSS growth and lower long-term earnings margins.

This unhappy outlook prompts a ratings downgrade to Sell from Neutral, while UBS' 12-month target price is slashed to $40 from $60 on a reduced multiple and lower EPS forecasts for FY23 and FY24.

Citi also downgrades its rating to Sell from Neutral, with a similar decrease in target to $42.80 from $58.00, on a likely reduction in the store rollout and higher costs. The broker also applies lower peer and market multiples.

It’s felt the near-term profitability of franchisees is unlikely to improve (thereby delaying the FY24 store rollout), which may require Domino’s to share margin with customers and franchisees.

Moreover, this broker is wary of increasing competitive risks in Australia and signs that delivery volumes remain under pressure.

From a ratings standpoint, Jarden and Morgan Stanley maintain the faith with Overweight recommendations, while Morgans also sticks with its highest designation of Add.

Jarden has growing confidence orders will turn positive, input costs will continue to ease, and franchisee confidence should lift, via cost-out measures. As a result, accelerated earnings are expected, along with an improving return on invested capital (ROIC) and a higher valuation multiple.

Food costs are coming down in the APAC region and should benefit Domino’s in the first half of FY24, according to Morgan Stanley. While these costs are yet to decline in Europe, the broker notes energy prices are beginning to fall.

Cost Initiatives

The company announced a target for annualised cost savings of $53-59m over a two-year period, with a third to be shared with franchisees.

Morgans believes plans to improve network earnings (EBIT) by $25-30m from FY24 appear achievable, though points out details around $20m of the savings will not be fully disclosed until August.

Jarden notes second half earnings guidance was lowered by around -21%, though felt cost initiatives, the exit from Denmark and the closure of unprofitable stores signals a more disciplined approach to capital management.

Balance sheet risk?

Management is expecting to incur one-off costs of -$80-93m though does not anticipate debt covenants will be breached. The costs are mostly non-cash in nature, which will help to improve the leverage ratios.

UBS is forecasting a lower dividend and future capex to avoid a net debt/EBITDA covenant breach. While Morgans believes a reduction in profitability will take pre-AASB 16 leverage for this ratio up to 2.5 times, a further deterioration is not expected.

However, Morgans acknowledges there is a risk of breach should cost savings not eventuate.

FNArena's daily monitoring consists of six brokers who actively cover Domino's Pizza Enterprises, though Ord Minnett (Accumulate, $68 target) is yet to update research. The average target price decreased by -16% to $53.63, which suggests 23.2% upside to the latest share price.

There are three Buy (or equivalent) ratings, one Neutral and two Sell recommendations.

Overweight-rated Jarden is not a database broker. This broker lowered its target to $68 from $72.

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