At market open this morning, Domino's Pizza Enterprises Ltd. (ASX: DMP) hit a new all-time high of $76.80. With the full year report expected out on 16 August, today's optimistic buyers are clearly expecting big things from the company.
Yet, trading at an eye-watering 70+ times its forecast earnings for the full year, are today's buyers really making a good decision – or is all of the good news already factored in to the share price?
The bull case
- At the half-year report in February, Domino's reported Group Same Store Sales (sales for existing stores across the whole company) growth of 10.3%
- Recent acquisitions in Germany and France have not yet begun contributing to reported results
- A number of new technology and operational initiatives including Smart Watch ordering and the 20 Minute Delivery Guarantee to drive demand
- Well aligned CEO with long-term mindset; targets include elimination of artificial colours and flavours plus 10-12 minute delivery time nationally
- Ample room to grow organically if Australian tech and delivery initiatives can be replicated and deliver similar performance overseas
- Interested in further overseas acquisitions
The bear case
- Priced to perfection – no room even for above average performance in today's share price
- Trading at 11 times its book value, and 70 times forecast full year earnings
- Upcoming employee wage negotiations have real potential to impact profits and thus the share price – maybe even the company's competitive position
- Making large acquisitions aggressively – potential for poor investments or underperformance
- Highly competitive segment
So?
Sounds good, right? Domino's is a great business, but I don't believe it's a great investment today. Thanks to its elevated price, only one thing needs to go wrong for air to start leaking out of the Domino's balloon.
The company has been aggressively acquiring new businesses and any of a combination of a poor acquisition, slowing same store sales growth, rejuvenated competition, margin pressure due to higher wage costs or even growing market scepticism that the company can maintain its performance could be enough to see shares decline.
Deutsch Bank analyst Michael Simotas was quoted in Australian financial media a month ago as saying that Domino's Australian profits could take up to a 24% hit once a new wage agreement is struck. In a marketplace that Domino's dominates due to its cheapness, this creates risks to the company in terms of its popularity, and opportunities for competitors. It also should raise eyebrows with readers who have watched other pizza franchises crumble – with high wage costs being universally blamed.
I do not believe there is a margin of safety in shares at today's prices, and I believe investors are buying a business that a) needs to execute almost perfectly for several years to justify today's prices and b) has a greater likelihood of seeing share price declines than rises from here, at least in the next two years. There's no need to race out and sell your shares, but it's tough to describe Domino's as a 'Buy' today.
