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Why the Domino’s Pizza Enterprises Ltd. share price is falling today

The share price of Domino’s Pizza Enterprises Ltd. (ASX: DMP) is getting burnt with the stock tumbling on fresh concerns that the fast food franchisor may miss its growth guidance.

The stock lost 3.3% to $42.42 during lunch time trade, when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is rallying 0.5%.

Fears that Domino’s franchisee store-split strategy is flawed as reported in the Australian Financial Review are the likely cause of the sharp decline, although there is another growing risk factor that could weigh on the stock this year.

A store-split is when a franchisee is asked to open a second store in his or her territory in an attempt to increase sales by bringing in new customers and to improve delivery times.

Domino’s is counting on this strategy to deliver most of its growth with the franchisor planning to open 400 new stores in Australia and New Zealand by 2025.

Store-splitting can really pay off if it leads to a meaningful increase in sales but this may not be the case as a number of franchisees have complained that the cost of setting up a new store and increasing competition is leaving them worse off.

Credit Suisse estimates that new stores opened under this strategy in Victoria (where there are fewer stores per capita than in New South Wales) will have to generate an incremental 50% increase in sales for the franchisee to breakeven.

There are allegations that franchisees who refuse to participate in store-splitting are being forced to sell their stores at a steep discount to fair value to others who are favoured by Domino’s.

This issue could leave a bad taste in shareholders’ mouths as a parliamentary enquiry into franchising kicks off next month.

This could be Domino’s version of the Banking Royal Commission which has triggered a sharp sell-off in big financial stocks like Commonwealth Bank of Australia (ASX: CBA) and AMP Limited (ASX: AMP).

The last thing the franchise sector wants is stricter government oversight as that will likely lead to further earnings pressure for Domino’s and its listed-peers Collins Foods Ltd (ASX: CKF) and scandal-ridden Retail Food Group Limited (ASX: RFG).

Until we get more clarity into what the parliamentary enquiry will uncover, these stocks are likely to underperform the sector as investors are likely to sidestep the sector after being caught with their pants down by the shocking revelations at the Banking Royal Commission.

The good news is that there is an alternative sector with a much more bullish outlook. The experts at the Motley Fool believe that this niche sector will make a big impact on our market in 2018 and beyond.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Domino's Pizza Enterprises Limited. 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 Scott Phillips.

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