Domino’s Pizza Enterprises (ASX: DMP) share price dropped 25% after the company’s 1HY23 results showed a surprising drop in earnings for the period compared to pcp (prior comparable period) despite the company’s flat guidance provided in December 2022.
The report showed a 21.5% drop in the period’s earnings year-over-year, and the company slashed its interim dividend payout by 23.8% to 67.4 cents. The disappointing results came as the company’s sales declined despite the organic addition of 79 more stores in the period as same-store sales growth fell after DMP tried to pass through inflationary pressures to maintain its stores’ profitability.
To give a little bit of background, new readers to DMP can read our last article about the company by using this link. Domino’s Pizza Enterprises Limited (ASX: DMP) is Domino’s largest franchisee outside the USA. It holds the master franchise rights to Domino’s brand and network in Australia, New Zealand, Belgium, France, The Netherlands, Japan, Germany, Luxembourg, Taiwan, and Denmark. As of today, DMP has a network of circa 3700 stores.
Customers turned out to be more price sensitive than DMP expected
DMP was forced to lift its prices sometime in the period to protect its stores’ profitability against inflationary pressures. But it saw the increased costs of delivery significantly impact customers’ order frequency. The impacts of higher prices were felt most strongly on the company’s European operations as those nations are more affected by inflation than the APAC region. DMP’s warehouse earnings were also impacted by lower than anticipated volumes and delayed pass-through of higher costs of goods sold.
The company has seen the slowdown in its sales growth continue to the second half in the months of January and February 2023. The trading data from the first 7 weeks of 2HY23 shows a 4.2% increase in sales growth, which is owed to the company’s Malaysia and Singapore acquisitions, while same-store sales in the period show a 2.2% decline.
Domino’s stock is covered by 14 analysts and based on their consensus estimate, DMP’s FY23 earnings are expected to see a decline of 10% from the previous year. However, we think this estimate might prove too optimistic as we expect the current economic slowdown to last until the end of FY23, at the very minimum. Therefore, we use a higher decline rate of 25% in the company’s earnings compared to FY22 to estimate FY23 earnings, which is slightly higher than the 21.5% drop experienced in 1HY23 earnings. This is because we expect consumer spending power to decline further in the second half by the expected rise in unemployment rates over the next few months. This gives DMP a forward P/E multiple of 39x at the current share price of $53.70.
DMP is paying out an interim dividend of 67.4 cents (60% franked) from earnings per share of 82.5 cents in the first half with an ex-dividend date of 28 February 2023 and a payment date of 16 March 2023. This represents a payout ratio of almost 82%, almost in line with the pcp. Assuming a similar payout ratio for the second half as well, we estimate DMP’s forward dividend yield to be about 2.1%, partially franked.
DMP’s net debt increased by $95m in the period despite an equity capital raising of $165m in December 2022. This was mostly the result of a $202m net cash payment for the acquisition of Malaysia and Singapore operations. The company’s net leverage ratio in the period increased to 2.1x, but it’s still significantly below the 3.0x banking covenant requirement.
DMP’s decision to continue expanding its store network despite the ongoing uncertain economic time has cost it in 1HY23, and we anticipate more pain in the medium term before gains in the long term. DMP’s business is simple, and it’s to sell pizzas at a competitive price through outstanding digital sales channels and fast delivery. So we think the business is set to thrive in the long term. But given the stock’s valuation multiples and the medium threat to its earnings, we downgrade our recommendation on DMP to “HOLD.”
From a technical analysis perspective, the first support for DMP’s share price is $50.00 (the green line on the chart). In the case of a confirmed break below this level, the next support level for DMP’s share price would be at $36.00 (the red line on the chart).
Domino’s Pizza Enterprises, Monthly Chart in Semi-log Scale (Source: Metastock)