Japan Drags On Domino’s Growth Profile

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Domino’s Pizza’s rapid covid era expansion in Japan has led to difficulties, impacting on store rollout and sales growth plans.

-Domino’s Pizza facing problems in Japan and France
-A&NZ and Germany holding the fort
-Store rollout plans paused
-Investment in products and marketing to increase

By Greg Peel

Domino’s Pizza Enterprises ((DMP)) holds franchise rights for the Domino's brand in Australia, New Zealand, Belgium, France, the Netherlands, Japan, Cambodia, Germany, Luxembourg, Denmark, Taiwan, Malaysia, and Singapore.

Domino’s rapidly expanded its Japanese store network during covid when sales boomed, growing to over 1000 stores from 600 in June 2019. Post pandemic, however, that expansion is coming with severe growing pains, with many of the network stores immature and still establishing themselves in their respective markets.

This was the story from Domino’s investor day last week.

By contrast, some of Domino’s largest markets, including Australia and Germany, are performing strongly, Ord Minnett notes, which should increase the appetite for new store openings.

Management flagged its organic store growth target of 7-9% will be difficult to achieve in FY25. Store openings and same store sales growth have been the key growth drivers for the business in the past, Macquarie notes. With same store sales targets of 3-6%, and store opening targets now unlikely to be achieved, this changes the growth profile of the business.

Store growth is a key feature of the Domino’s investment thesis, UBS points out, but it’s a long way to go to the target of 7100 stores, up from 3841 currently, while Domino’s market share is low.

The markets with significant store growth headroom (France, Japan, Malaysia, Taiwan) are not performing well, finds UBS, with Germany the only high headroom market performing well, while strong performing markets have less store growth potential (Australia/New Zealand, Singapore).

What to Do?

Domino’s outlined detail on its addressable market and plans to grow share via product quality, delivery speed, marketing and meal occasions, with an opportunity to reduce delivery costs by -30%.

In Japan, a lower entry price point has not stirred a consistent lift in volumes, Petra Capital notes. The launch of a “from JPY790” range is not resonating with carry-out customers — a key market segment in Japan. The longevity benefit of promotions is questionable; and current inconsistent trends means it will likely take longer to lift weekly store orders volumes from 500 to be consistently at 600, as is the goal. This in turn has bearing on the store reopening horizon.

It now seems possible there could be several store closures in Japan, Citi suggests, which could result in investors questioning the rollout potential in this market and/or mean that 2033 store targets (2,000 stores in Japan by 2033 versus 1,015 now) are more challenging to achieve.

While some new prefectures are relatively immature and as a result sales have underwhelmed, Citi questions whether consumers in some of these newer prefectures are less inclined to consume pizza relative to the more mature prefectures of Tokyo, Nagoya, Osaka for more structural reasons such as lower incomes or different tastes (see: raw fish).

Global franchisee profitability has fallen to $95,000 per store from $130,000. Management noted its intention to return to profitability of $130,000 which it believes will reignite store opening growth. For it to achieve this, it will need to grow revenue through new products with improved margin profiles, penetrating new markets and bringing cost out of the business without sacrificing quality.

Macquarie believes this brings upside risk to costs as Domino’s reinvests in its franchisees, R&D, and marketing costs.

Growth Potential

Domino’s plans to pause its store rollout in Japan, as a result it will miss its 7-9% store rollout target in both FY24 and FY25.

Qualitatively, the company noted a shift from a focus on being a digital leader (albeit still important) to focusing more on products, though Goldman Sachs believes that with increasing complexity across 12 markets, digital leadership is foundational for the company to maintain its strategic moat, including product innovation.

The lack of focus/investment on building a leading omni-channel first party consumer data platform, analytics, and scalable use-cases has underwhelmed Goldman Sachs, and this broker retains a Neutral rating.

Little was said about France at the investor day, with management saving the news there for its European updates.

Despite slower rates of store growth and a challenged performance in key store growth markets, UBS believes there remains significant growth potential in same store sales led by Australia/New Zealand now and global store growth in the long term. For now, UBS sticks with Hold.

Citi (Neutral) left last week's investor day more cautious on the company's immediate and longer-term rollout prospects, which could have implications for the stock's premium multiple.

While commentary for A&NZ/Germany remains upbeat and restructure savings are still on track, with Japan misfiring, combined with continued challenges in France, Malaysia, Taiwan and the Netherlands, Petra Capital takes a more cautious stance, downgrading to Hold from Buy.

The issues facing some of the key markets for Domino's have not improved, Macquarie (Neutral) suggests, with the slowdown in France and Japan appearing to be structural. With a slower store rollout, this broker believes growth in the business will be muted over the next couple of years as Domino’s reinvests in the franchise.

Barrenjoey notes Domino’s is now a complex business with significant execution risk across multiple countries. This broker pushes out its margin recovery forecast even further which reduces FY24-26 earnings forecasts.

Barrenjoey nevertheless retains Overweight, feeling the market is capitalising cyclically low earnings on a discounted multiple, while acknowledging its thesis could take time to play out.

Jarden (Overweight) believes the worst is behind Domino’s, having taken steps to improve the cost base, franchise profitability and value proposition, but Japan will take time. Ultimately, Jarden views the decision to slow the near-term rollout in Japan as positive long term in that it should be ROIC-accretive (return on investment capital), with Domino’s reiterating long term targets.

That, coupled with improving same store sales growth across A&NZ and Germany, gives Jarden confidence earnings will reaccelerate, with FY25 to be materially stronger.

Ord Minnett suggests the outlook for new stores remains robust. In Germany and France Domino’s only covers about a third of the large opportunity, with only 1% of the fast food market, compared to Australia’s 5%, New Zealand’s 4% and the Netherlands 3%.

Ord Minnett retains an Accumulate rating.

Six brokers monitored daily by FNArena cover Domino’s, but Morgan Stanley (Overweight) and Morgans (Hold) have not piped up since the investor day. As it stands, there are two Buy or equivalent and four Hold ratings on the stock with a consensus target price of $49.92, down from $50.42 previously, which implies 33% upside.

Targets range from $41.00 (Macquarie) to $61.00 (Ord Minnett), if we don’t count Morgan Stanley’s February target of $68.00.

Among brokers not monitored daily, Petra Capital has cut tits target to $40.80 from $47.50, Jarden to $48.00 from $49.00 and Barrenjoey to $51.00 from $56.00.

Goldman Sachs retains $39.70.

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