Is Domino's Pizza Enterprises Ltd. shrinking its way to growth?

Media reports suggest that Domino's Pizza Enterprises Ltd. (ASX:DMP) could be investing in smaller pizzas.

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Fairfax media reported this morning that Domino's Pizza Enterprises Ltd. (ASX: DMP) could be set to release a new range of smaller, higher-priced pizzas, "ensuring that as a brand Domino's stands for more than just cheap $5 pizzas."

Investors may be surprised to at the about-face from the company, given the significant effort it has taken in the past to lower the price of its pizzas, as well as the heat it has taken from media reports about the lack of viability of the franchise model.

If media reports prove accurate, Domino's could be aiming to introduce a more premium range of products in order to lift the standards and/or perception of the brand, as well as to entice more quality-minded customers. Alternatively, I would suggest that the changes could be an effort to lift the margins of franchisees.

As we have written previously, Domino's has switched its beverage provider from Coke to Pepsi. While the exact cause of that change is unknown, one definite benefit will be wider margins for the company (Pepsi is a lower-cost Coke competitor), assuming that in-store pricing stays the same. The latest menu revamp could be another change aimed at improving franchise store profitability.

Improving the lot of franchisees?

Earlier this year, Domino's was the subject of media reports implying that the company was complicit in the underpayment of thousands of workers in an effort to keep costs down. Investment bank Citi has suggested that the company is as much as 16% overvalued as it may need to share more of its profits with franchisees in the future.

Although Domino's is currently auditing all its Australian stores for wage compliance, management announced on 30 May 2017 that the audit would be pushed back for 6 months '…because of the number of stores being audited'. Which is an unusual complaint given that the number of Domino's stores is a known amount (we hope) and presumably had to be communicated to auditor Deloitte before they commenced.

With all these concerns, it is not surprising that Domino's is one of the most short-sold companies on the ASX, with 10.2% of its shares held for short sale.

Speaking for myself, there is a price at which I'd buy Domino's, but $53 isn't it. I think that today's prices factor in a considerable amount of the next 3-5 years of growth, and don't allow much of a margin for uncertainty. As a result, I'm avoiding the company today.

Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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