The Domino’s Pizza Enterprises Ltd. share price is down 8% on lukewarm results

The Domino’s Pizza Enterprises Ltd. (ASX: DMP) share price dived 8% to $45.63 after it released its half-year results to the market this morning. This is despite what looked like strong headline results, with revenues and profits up sharply. Here’s what you need to know:

  • Revenue grew 5% to $568 million
  • Net profit after tax grew 17% to $59 million
  • Underlying net profit after tax grew 5% to $63 million
  • Earnings per share grew 5.8% to 71.3 cents per share
  • Dividends per share were up 20% to 58.1 cents per share
  • Group same store sales (SSS) growth of 4%
  • 2,193 stores, reaffirmed outlook of 4,650 stores by 2025
  • Continuing to pursue possible acquisitions
  • Outlook for stronger second half, full year profit growth of +20%, and +310-330 new stores

So what?

The market seemingly did not expect the weaker first half, despite this being flagged at the Domino’s annual general meeting (AGM) last year.

Same store sales (SSS) growth was also weak after several strong years, although results in the early weeks of 2018 appear promising.

Europe and the ANZ region are still growing meaningfully, and management expects performance to improve in the near term due to new products and a variety of new measures including improved delivery times and online transaction interfaces.

Japan continues to struggle, with sales and earnings falling sharply due to disappointing Christmas trading and adverse foreign currency movements. Net debt blew out to $373 million due to acquisitions and a buyback, although the company’s ‘leverage ratio’ remains acceptable at 1.3x earnings.

Notably there was no real update on the company’s long-running wage audit, which is ‘close to completion’ and has found that 646 stores require ‘little or no action’ from a total of 669 stores. Just 15 stores have been issued with a breach notice.

To my mind these results are in stark contrast to media coverage of Domino’s and the franchise industry, and suggests either media reports are basically entirely wrong, or that Domino’s is ‘smoothing’ the figures somehow. For example it was not made clear how many of those 646 stores actually required action to remedy. Be that as it may, this is just something shareholders will have to keep in the back of their mind.

In related news, Domino’s is being sued by Pizza Sprint franchisees in France as well as the French Ministry for Economics and Finance regarding practices that pre-date Domino’s acquisition of Pizza Sprint.

Reading between the lines, and noting some of Domino’s measures for “supporting Franchisee performance” – like the introduction of performance benchmarking against all other franchise peers, and goals to “Maximisze profit opportunities for each Franchisee” – I’m doubtful Domino’s has made any material changes to its relationship with franchisees.

Maximising profit opportunities sounds a lot like “If you sell more stuff, you’ll make more money” rather than any substantive change to franchisee store margins or profitability. In fact I’d suspect that performance benchmarking will become another tool to place further pressure on franchisees. I’m just speculating here, but if the franchisee model is really under pressure, it will work until it doesn’t. That is something all shareholders should keep in mind.

Now what? 

With business seemingly booming, the biggest question for investors is whether today’s price reflects good value to buyers of Domino’s shares.

At ~40-odd times earnings – for a pizza company – my first instinct is that it does not. However, Domino’s has plans to roughly double its number of global stores in the next 7 years, and there are a number of adjacent markets it’s looking to move into – such as the lunch market, via its 20-minute delivery promise. Same Store Sales growth has been persistently incredible and if it continues the company could justify today’s prices.

How many new products can Domino’s introduce? With chips, sub sandwiches, milkshakes, chicken wings, and a variety of other delicacies already on the menu, Domino’s is surely close to the limit of new products it can invent.

The company is an impressive one but in my opinion much of this is already baked into the share price, and several risks, such as the franchise model, are not accounted for at all.  I’ll be watching from the sidelines.

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