Why this analyst thinks the Domino’s (ASX:DMP) share price is a ‘buy’

Analysts at Goldman Sachs recently upgraded the Domino’s Pizza (ASX:DMP) share price to a buy after a strong FY20. Here’s the lowdown…

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Pizza delivery company Domino’s Pizza Enterprises Ltd. (ASX: DMP) has had an impressive year. Despite the operational difficulties caused by the COVID-19 pandemic, including delayed store openings across the Australia and New Zealand regions, Domino’s has still managed to deliver significant revenue growth in FY20.

In its FY20 annual report, Domino’s reported global sales of $3.27 billion, an increase of 12.8% over FY19. Earnings before interest, tax, depreciation and amortisation (EBITDA) came in at a record $303 million, while net profit after tax grew by 3.3% year on year to $145.8 million.

The strong result was driven by impressive gains in the Japanese market. Domino’s Japan delivered 25.9% growth in sales year on year, with 75 new stores opening across the country in FY20. Sales growth was a more modest 5.1% in Europe and 4.1% in Australia and New Zealand, with both of those geographies reporting small declines in year-on-year EBITDA.

Domino’s has also responded well to the ‘new normal’ of doing business under COVID-19 restrictions. It invested heavily in personal protective equipment, boosted its digital sales channels, and pioneered COVID-safe strategies such as ‘zero contact delivery’.

The rising Domino’s share price

The company’s strong financial performance has had a positive impact on the Domino’s share price. Since bottoming out at a 52-week low of just $41.66 during the mid-March market crash, Domino’s shares have now skyrocketed more than 100%.  

But there is the risk these big gains could cause the company’s shares to become too overvalued. After the recent surge in its share price, Domino’s is now trading at more than 50x earnings.

Should you invest?

Despite these ballooning valuations, Goldman Sachs remains bullish on Domino’s shares. The broker upgraded Domino’s to a buy at the beginning of December, and slapped a 12-month target price of $88 on the company’s shares. However, it is worth bearing in mind that, at the time of the Goldman Sachs recommendation, the Domino’s share price was trading at just $74.02, but has since climbed to $84.09. This means Goldman’s target price now only offers a 5% upside to Domino’s current share price.

The analysts at Goldman Sachs thought Domino’s offered better growth potential than ASX fast-food peers like Collins Foods Ltd (ASX: CKF), which operates KFC restaurants in Australia, Asia and parts of Europe, as well as the Australian Taco Bell network.

Goldman Sachs was particularly impressed by the pizza chain’s expansion into the German and Japanese markets and argued this would continue to drive margin growth for Domino’s in FY21. The broker also noted that a return to a more stable operating environment post-COVID could accelerate pipeline growth.

Goldman did, however, point to some downside risks to an investment, including Domino’s underperformance in France, where COVID-19 restrictions forced stores to close and had a much more severe impact on sales. If this market continues to lag in FY21, it could slow down the company’s overall business momentum.

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Motley Fool contributor Rhys Brock has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Collins Foods Limited and Domino's Pizza Enterprises Limited. 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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