3 reasons why Domino’s Pizza Enterprises Ltd. shares are too expensive

Credit: Dennis Wilkinson

Domino’s Pizza Enterprises Ltd (ASX: DMP) is one of the biggest Australian-owned takeaway chains with 714 outlets in Australia and New Zealand. Domino’s Australia currently has a market capitalisation of $6.1 billion, which is relatively high considering its US parent company is worth US$7.29 billion.

Domino’s Australia has served its shareholders tasty returns, with its shares up over 1,050% in the last five years. However, the share price has dropped down from $80 in August to $68 today, even with this drop in price its shares are looking quite stretched.

Domino’s shares are currently trading at 64x FY16 earnings and 49x FY17’s estimated earnings (source:Commsec). So shareholders are expecting a lot more growth. Is that expectation too optimistic?

Comparison to its fast-growing peers

The underlying Domino’s business will probably continue to have strong growth, however no business is “buy at any price”.

For example, look at Ramsay Health Care Ltd (ASX: RHC), it’s one of the ASX’s highest quality businesses and has big tailwinds. Ramsay is trading at 33.5x FY16 earnings and 29.6x FY17’s estimated earnings, which is much cheaper than Domino’s. Operating private hospitals seems like a better economic moat than pizza shops to me.

Another example is REA Group Limited (ASX: REA). It’s Australia’s largest property website owner, it also has a growing network of leading websites in other countries. REA is currently trading at 33.7x FY16 earnings and 29x FY17’s estimated earnings, which is also much cheaper than Domino’s.

I think the above two businesses offer much more value for the growth on offer.

Competition could also be a problem

Pizza Hut Australia has been lagging for the last few years, but there are signs it could start making a fight back. It was recently bought by private equity firm Allegro and three former McDonald’s executives. The new owners are now looking at buying the failing pizza chain Eagle Boys. A re-invigorated Pizza Hut could hamper Domino’s growth.

Retail Food Group Limited (ASX: RFG) continues to grow each year. Its two pizza brands, Crust and Pizza Capers, could also pose some problems for Domino’s.

Technology ceiling

I have been impressed by how many different technological initiatives Domino’s has come up with in the last few years. Some will have helped their earnings more than others. If competitors copy what Domino’s has implemented, it would lose its technological edge.

It also remains to be seen what more Domino’s can come up with, it may have run out of viable new ideas for the time being. The Domino’s Robotic Unit (DRU) could be a great idea, but it rests on the shoulders of how receptive pizza lovers would be to a drastic change in pizza delivery.

Foolish takeaway

Fast growing businesses have a place in every portfolio, however you should be mindful not to overpay for potential growth. I think Domino’s falls into this category and is worth being on your watch list, but potential shareholders would be wise to wait for a cheaper entry price.

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Motley Fool contributor  Tristan Harrison 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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