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Date : 14/03/2022

Domino’s Pizza Enterprises

ASX :

DMP

Market Cap : $6.98 Billion

Dividend Per Share : $1.735

Dividend Yield : 2.14 %

Buy

52 Week Range : $75.81 - $167.15

Share Price : $80.75

Quality company with quality earnings and a robust long-term growth profile. A 'Buy' from us.

Company Analysis

Domino’s Pizza Enterprises Limited (ASX: DMP) is Domino’s largest franchisee outside the USA. It holds the master franchise rights to the 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 more than 3200 stores as of 1H22.

DMP is a business focused on the long-term – this reflects not only a long-term track record of achievement but a continued outlook to the long-term growth ahead. This past financial year again demonstrated the value of this long-term focus, with successes achieved throughout the business by management and franchisees alike.

In FY21, Domino’s Pizza Enterprises and its franchisees opened 285 new stores across nine markets. The foundation for this growth, across Asia, Australia/New Zealand, and Europe, will continue to be the firm’s high-quality franchisees. The company’s diversification strategy is good, and it forms the bedrock of their consistent cashflows without over-reliance on any particular region. The management of these divisions is also structured well, with Domino’s appointing a different CEO to head each division.

The chart below shows that DMP has consistently grown its revenues across all 3 regions. Australia perhaps saw the highest growth in FY2020 due to a lower degree of coronavirus effects than the rest of the world.

In FY2021, a time when Europe was opening up and people were free to move about within the region, growth in revenues started to accelerate despite Domino’s not making an entry into any new region within Europe.

APAC is arguably the region that holds the highest growth potential for Domino’s. Along with Japan, DMP has added Taiwan into its operating region. These regions come with densely populated areas, leading to two benefits – one is that of Dominos requiring fewer stores since the region/country itself is small. This reduces costs significantly. The second is that there are many more consumers to attract than ANZ. Domino’s brand speaks for itself worldwide, and it should not be too hard for the company to capture new markets as and when they enter.

Another advantage that Domino’s has is its franchise model. DMP has and will continue to invest in their future growth and also in the next generation of franchisees who are currently working at Domino’s stores as managers or delivery experts. In FY21, 93.6% of new franchised stores were opened by existing franchisees or store managers. This model has a snowball effect given the strength of Domino’s brand.

DMP’s long-term commitment to the franchising model has benefited the business. It has also rewarded DMP shareholders; In FY21, the company delivered an underlying return on equity of 49% and a three-year average return on equity of 44%. It also allowed Domino’s to increase its dividend to shareholders by 45.4% to 173.5 cents per share. Total shareholder returns in FY21 were 76.75%, which placed Domino’s Pizza Enterprises Ltd in the top 20% of ASX-200 companies.

Domino’s Pizza Enterprises Ltd has outperformed most companies in Australia and some of the world’s best-known technology companies listed on Wall Street. It holds a long-term success story on the global stage. Domino’s approach has delivered results in each of their nine markets, and with the addition of a 10th market – Taiwan, with a population of more than 23.5 million people, the addition of Domino’s Taiwan to the company’s portfolio will expand the addressable Asian market by more than 18%, to almost 150 million people. The track record of success Domino’s has in Japan and the expansion into Taiwan firmly establish a centre of excellence for the Company in Asia and a platform for future growth.

Company Updates

Domino’s financial performance in FY21 beat market expectations. This resulted in the share price surging from about $85 as we entered CY21 to over $167, riding on the back of a fantastic FY21. At that point, we believed that DMP shares were overvalued, and it even made into our list of stocks to Avoid, given the overvalued multiples it was trading at. However, as volatility crept in from the end of CY21 due to inflation fears and now the obvious risks of the Russia – Ukraine war, DMP shares have more than halved. Our analysis suggests that it’s a fantastic entry point into a quality company with an exceptional brand value that will show that the brand and the company itself keeps growing efficiently.


Source: Tradingview.com

FY21 Performance Set the Stage

The FY21 performance set the stage, and we need to look at it in detail to understand Domino’s incredible performance drivers. The highlights of FY21 were:

  • Network sales: up +14.6% to $3.74b
  • Online sales: +21.5% to $2.93b
  • Underlying EBIT: +27.2% to $293.0m
  • International EBIT: +41.4% to $199.5m, 68.1% of Group EBIT
  • Free Cash flow: up +40.2% to $216.2m
  • Dividend payout ratio to be increased to 80% (up from 70%)

DMP announced global food sales across the network increased by $476.5m to $3.74b (+14.6% on the prior year, +9.3% on a Same Store Sales basis) with Full Year EBIT of $293.0m (+27.2%). In the Second Half, food sales increased +12.8% to $1.9b (+10.2% on a Same Store Sales basis). It has been a very difficult period for the F&B industry during the pandemic. DMP has combatted all the challenges thrown at them and delivered a fantastic result.

Stores in each market responded to local conditions – societal restrictions remained in place in most markets during that period, affecting carry-out sales. However, delivery orders remained strong, and Domino’s milked this opportunity with a lean business model.

DMP took it one step further and opened a record 285 stores during the full-year period. New stores openings (+285, +10.7%) surpassed Domino’s 3–5-year outlook (+7-9%), with positive contributions from all markets, led by Japan setting a record of 126 new stores – the first time a DMP market surpassed 100 stores in a calendar year.

Domino’s performance throughout COVID is a direct result of its long-term investments and strategy, fortressing its markets, digital delivery, 3TEN, and indeed franchising itself. DMP invested in the future of the German market with two acquisitions, and the results of a unified, national brand and a regional approach to store development are clear in the record store openings (+40) and shared profit for Domino’s and its franchisees. Similarly, in France, DMP made targeted investments in its Franchisees in FY19/20 and in-store development teams, delivering strong year-on-year growth in new store openings (+38 in FY21).

In Japan, DMP invested in supporting the firm’s most experienced store managers to become franchisees and, more recently, to ensure freight costs did not disadvantage regional areas – the results have surpassed expectations with 126 new stores opened. In every market, DMP’s fortressing strategy demonstrates that more stores allow for increased marketing investment and increased customer demand, needing more stores to meet this demand.

The results in FY21 highlight the importance of franchisee profitability, particularly returns on new stores, to their growth. It builds a stronger business for all, and DMP is applying this growth focus to Australia/New Zealand through Project Ignite, a multi-million program to build out the company’s store network, positioning it for existing and future delivery demand. These investments should increase DMP’s outlook for new store openings for the next 3-5 years to +9-12% (up from +7-9%).

DMP is also intended to fortress its digital offerings, investing in DMP’s online platforms and the company’s ability to develop insights into the data collected. Data collection and analysis is at the core of every online business’ marketing strategy, and this will therefore ensure and create more efficient stores for DMP’s franchisees.

We expect Domino’s Pizza Enterprises to deliver significant profit increases over the medium term, driven by new store openings and sales growth. The company’s business has the track record, cash flow and expanded debt facilities to deliver on its strategy. The company is also intended to reinvest in long-term growth, benefiting franchisees and shareholders.

APAC – Sales +30.9% to ¥77.5b (+21.8% SSS), 126 new stores, EBIT ¥8.8b (+52.8%)

The results in Japan resulted from a long-term strategy and world-class execution. DMP’s store managers and franchisees (now more than 50% of the DMP network) have demonstrated that High Volume Mentality is a Domino’s Japan mentality. Domino’s has expanded its footprint and won market share by delivering what they do best. Domino’s said that COVID-19 brought new customers to trial their meals and service. Long-term investment decisions underpinned the results in FY21: in two years, DMP has added 200 stores to their business, expanded the franchisee base, and changed the way they deliver value – this has set the stage for DMP’s next phase of growth. In Japan – franchisees are expanding into new territories, and DMP said they would continue to invest with them to accelerate their growth.

Domino’s Pizza Enterprises secured foreign investment approval to acquire its 10th market – Taiwan, with the transaction now concluded in late 2021. This immediately added 157 new stores to DMP’s business, with a long-term market potential of more than 400 stores. We believe there is a tremendous opportunity in this market to apply the lessons of Australia/New Zealand, Europe and Japan to complement their local expertise with additional resources and investments. It’s essentially more of the same. Domino’s brand and tried and trusted execution strategy will ensure that they generate high Return on Investment, as they have done in other markets.

Europe – Sales +23.0% to €921.5m (+12.1% SSS), 129 new stores, EBIT €55.2m (+48.3%)

In Europe, DMP had implemented a long-term plan despite some of the most challenging COVID-19 conditions in the DMP network. The challenging the conditions have been in DMP’s operating environment for over
than 12 months, including curfews that prohibited carry-out during dinner periods in France and societal
restrictions in Benelux. DMP did not just survive but grew during this time – opening a record number of stores during pervasive restrictions and servicing rapid delivery uptake.

Notably, the two biggest engines of DMP’s future growth in Europe are Germany and France. These regions have set new records for store openings in the previous year. This was a direct result of DMP’s decision to invest in franchisee partnerships and incentives in France and reach scale through initial acquisitions and store conversions in Germany, allowing the company to start from a unified national brand.

Australia/New Zealand – Sales +6.5% to $1,296.4m (+4.5% SSS), 30 new stores, EBIT $116.8m (+14.1%)

Australia/New Zealand CEO Nick Knight said the domestic business had grown through COVID-19 because of a strategic shift in the franchisee base. The recent performance results from a decision to invest in Operations 360 and to operate a larger number of corporate stores with higher costs, where former franchisees no longer had the passion or capability to excel in this business.

Dominos has seen a lift in operational performance and a resulting improvement in franchisee profitability because their refranchising and new stores have come from within. DMP will reinvest to ensure they take the next step to build out in opportunity markets – more stores reduce the last mile of delivery, giving customers a better experience (increasing brand value), and franchisees will thus operate with improved unit economics.

Industry Analysis

Domino’s Pizza is the global industry leader in the QSR Pizza sector. The company has grown into one of the most recognized consumer brands globally. It has remained committed to product quality, innovation, customer satisfaction, and customer convenience throughout its history.

At the end of 2020, the company had 17,644 stores operational throughout the globe, of which 6,355 were operational in the United States and the rest outside the US. During the pandemic, the company was quick to make changes to its operating model to cater to the changed circumstances and customer needs inside and outside the United States. The result was that while several companies across various industries experienced severe losses during the pandemic, Domino’s experienced significant growth in sales and revenue.

Domino’s caters to the needs of a very diverse customer base that includes customers from various economic segments and backgrounds. Apart from that, it also caters to customers across diverse age groups. You can say that the largest target segment of the company is the middle-class customers in the young to middle age segment. The growth of middle-class consumers as a profitable customer segment in the past several years has caused the fast-food brands to shift the focus of their product and marketing strategies towards this segment. Domino’s targets customers in the 18-40 age group mainly.


Source: DMP

(Product + Service + Brand Image) / Price = Value. This is the equation that Domino’s operates by globally. It is the bedrock of their strategy that helps them dominate in every country DMP operates in. While the USA and Canada are the largest markets, they are the largest quick-service pizza operators in ANZ, Europe, Japan, and now Taiwan.

What does a market leader do now after years of sheer dominance? They increase their global footprint sustainably and set growth aspirations at a modest rate to keep the level of efficiency high and stay true to its equation.

Beyond Covid19, Dominos is looking to double its store footprint by 2031. ANZ, Europe, and Japan are forecasted to see a massive uptick in stores. Additionally, we expect Dominos to aggressively expand in APAC and Europe during this time. Both regions are densely populated with a growing middle-class population – Domino’s primary target market.


Source: DMP

Investment Thesis

So far, we have established the brand that Domino’s Pizza is, its performance that elevated the market share during the pandemic – a period where all F&Bs struggled to make ends meet, and the long-term growth strategy that Domino’s operates with – giving it a very structured and pragmatic operation style that will deliver shareholder value.

On the 8th of December, Domino’s announced that Japan has reached a significant milestone, now operating stores in all of the country’s 47 prefectures. With the opening of Domino’s Japan’s 862nd store and the first in the Shimane prefecture, Domino’s Japan has become the first pizza company with a national footprint. It is on track to achieve its 2000-store milestone by 2033.

Domino’s share price tumbled as the market expected 1H22 results to be higher. This expectation was largely because Domino’s finances catapulted during the pandemic. However, the company has always strived and said its long-term plan makes it a solid investment. Domino’s is well on track to meet its 2033 goal and the market not agreeing with a short-term performance during extraordinary times is a buying opportunity for long-term investors.

DMP avoided the temptation to take a defensive approach during the most uncertain times in our history. As a result, DMP has built a materially stronger and more resilient business in all markets. However, the investment means a temporary blip in margins.

Key financial results for the half ending the 31st of December include:

  • Revenue of $2.01 billion, up 11.1% year-on-year (YoY)
  • EBITDA of $212.8 million, down 2.5% YoY
  • Net profit after tax of $91.3 million, down 5.3% YoY
  • Interim dividend of $0.884 per share, flat YoY

Europe has been the standout performer, with sales and earnings increasing over 11%. The region opened 47 new stores bringing its total network to 1,329.

  • Germany: Positive growth in H1, with strong two-year CAGR – successfully cycling high comps in H1
  • France: Retained record delivery customers (now >50%), noting reduced carry-out is affecting performance
  • Benelux: Particularly positive growth in Benelux, from both carry-out and delivery
  • Store openings remain above pre-COVID-19 levels, with a high level of franchisee appetite for expansion
  • Franchisee profitability, and alignment with Domino’s long-term strategy, is positive vs. pre-COVID-19

Conversely, Australia and New Zealand (ANZ) and Asia record negative profit growth. ANZ division is currently undertaking Project Ignite, which aims to improve the profitability of underperforming corporate stores by transferring ownership to franchisees. New Zealand stores were also shut for four weeks during the half due to COVID-19 lockdowns.

Franchisees have demonstrated they are invested in our future. Franchisee enterprise expansion is strong –including recently through franchisee acquisitions or corporate store purchases. 58 franchisees expanded their business in H1 – 25 expanded by 2+ stores. 19 Corporate stores were franchised to existing store managers or franchisees. It was a record calendar year for organic store openings for ANZ is planned in CY22.

Domino’s ANZ appointed experienced leaders to CEO and CMO positions, focusing on enhancing existing strategies. Ongoing hiring efforts have allowed stores to resource larger delivery volumes vs. prior year. Heightened COVID-19 case numbers increased customer demand in Q1. There have been increased sales from Q2, and new menu offerings delivered strong H1 franchisee profits.

Despite significant community-wide challenges – stores reduced average delivery times. The newly launched Value Max range is resonating with customers and franchisees. The December trading period set a record for the network, with 405 stores breaking their weekly sales record. Significant progress made in re-franchising of corporate stores, with step-up in organic store openings planned in H2.

Asia added 99 new stores and acquired 156 as part of onboarding Taiwan to its network. Taiwan has performed above expectations, with sales growth and new store openings accelerating compared to pre-acquisition. Management noted the state of emergency in Japan as a major headwind.

Q1 Network Sales set new records, compounding very strong figures from prior periods:

  • Customer behaviour in Japan rapidly changed following the lifting of a nationwide State of Emergency in October 2021
  • SSS in Q2 was -12.4%, +27.9% on a 2-year basis, with stores experiencing a rebasing, not an ongoing decline
  • Despite this rebasing, Christmas trading set a new record
  • Japan set a new record for store openings (+140 new stores in Calendar Year 2021): franchisee appetite for new stores is strong, and management reaffirms outlook
  • Taiwan business is performing ahead of expectations – the high-quality team are excited to deliver, as part of the DMP family
  • Domino’s newest market opened 5 new stores – strongest new store growth half in 3 years
  • Planned investment in Taiwan will allow expansion, delivering on a long-term outlook.

Moreover, Domino’s has been accelerating its new store rollout, which places pressure on margins given the immaturity of new stores. Overall, the fall in earnings and profit looks to be a short-term blip that cannot be controlled by the firm.

As inflation rises, most consumer-facing businesses are expected to encounter lower sales as buying power drops gradually in the medium term. Domino’s plans to combat this and not just hike up their prices and pass it on to the consumer. The company is focussing on providing ‘more for more. As opposed to just hiking prices, DMP adds extra value to its product and thus shields margins. ‘More for more’ is an initiative that offers upsized meal offerings that are a win for customers and franchisees.

Given the strength of Domino’s brand and an extremely sticky customer base, these value-adding propositions will only continue to strengthen the brand and help in long-term value creation.

Outlook

For the first six weeks of 2022, network sales have grown 6.0%, while same-store sales have increased 1.7%. The business is on track to open 500 new stores in FY22, including the recent Taiwan acquisition. In summary, it was a soft result. But expect earnings to return to growth in the short-term as management executives on its growth strategy.

The market for delivered QSR and Immediacy Grocers is rapidly expanding – growing total demand and ‘contract’ labour market. QSR competitors and grocers are facing the inherent challenges of delivery operations. During this time, Domino’s Pizza Enterprises has reduced delivery times across markets. Improved execution has grown more frequent cohorts.

New Organic Store Additions Outlook of 9-12% remains on track, with Domino’s expected to add +500 stores to its network this Financial Year alone. Management continues to invest in its future, with Net CAPEX Outlook unchanged at $100-150m, as the firm assists franchisees with store expansion and invest in future digital technologies and initiatives. Management Outlook illustrates DMP’s medium-term annual growth expectations; however, guidance was not provided in the announcement.

Our analysis suggests that DMP’s expansion strategy will yield considerable revenue and earnings growth. As the world emerges out of the pandemic and people slowly move back into working at the office and once again leaving their homes every day, the demand for QSR will increase. With their brand power and market leading positions, Domino’s will be able to leverage this tailwind and take advantage of it.

We expect DMP to grow its revenues by around 8% in FY22, given that the first half of the year was affected by the pandemic and the second half is when the operating environment should start easing. FY23 onwards, we expect revenues to grow at around the 12%-13% mark. Margins, as a result, will expand with an increased volume of sales. DMP is entering consumer heavy markets in Europe and Asia – resulting in high volume of sales.

The Financial Health of DMP remains strong. ROE remains strong due to continued, robust profits. ROCE remains strong due to robust EBIT, whilst DMP continues to invest in international markets and corporate stores. Interest Coverage Ratio improved due to robust EBITDA and low interest-bearing debt. Net debt increased by $162.6m vs. FY21, primarily due to: Taiwan acquisition ($79.4m) and higher CAPEX ($29.7m). The net Leverage ratio increased, primarily due to higher net debt.

The underlying EPS came in at $1.055. The EPS has a positive trajectory of 11.9% CAGR over the last 2 years and 19.8% CAGR over the past 10 years. We are confident of this trend continuing and delivering shareholder value in the long term.

Valuation

To best estimate the long-term value of Domino’s Pizza Enterprises, we have adopted a detailed Discounted Cash Flow Valuation. We believe the DCF offers the best possible cases to value DMP as it is a growing firm with rock-solid financials and a steady source of revenues and earnings.

We begin the process by estimating the firm’s revenues, earnings, and cash flows. Following this, we estimate the enterprise value of the firm.

For the valuation, we have assumed a 7% discount rate and a 2% perpetual growth rate for DMP, which is in line with the long-term (perpetual) inflation. Since the forecasts here are in the future, they first need to be brought back to today’s terms by calculating their respective Present Value.

We then arrive at an Enterprise Value and Equity Value for DMP and finally an implied share price of $95.58 a share – which represents an upside of 19% considering today’s share price of $80.75 a share.

Technical Analysis

DMP shares have been on a roller-coaster since 2019. Since Domino’s Pizza hit its multi-year low after a pretty bearish three years, it rebounded quite impressively towards its all-time high in September 2021, reaching almost $168 per share. DMP has been considered one of those overvalued shares. However, a massive pullback recently dragged Domino’s stocks by -51% down to a double-digit share price of $80.75. DMP has found its support this week, holding the 200 weekly moving average tightly after about six months of freefall.

We believe it is the right time to consider jumping on it, as DMP’s valuation appears to be back to a reasonable level. Technically, DMP is now sitting at multiple support levels. We have the 200 weekly moving average and the 61.8% Fibonacci level from the current swing low, which could be a solid foundation for a consolidation. Furthermore, Domino’s RSI has reached the oversold territory on the weekly timeframe, another signal confirming an imminent trend reversal.

We expect in the medium term a price consolidation in the $80 and $90 range with a possible rally towards the psychological price tag of $100 per share. This coincides with our valuation, a +20% upside potential from the current market price.

Chart, histogram Description automatically generated

Recommendation

Domino’s Pizza Enterprises is a high-quality company with a demonstrated history of capturing long-term shareholder value. The company is expanding across Asia, Europe, and ANZ as a part of its proven long-term growth strategy. Domino’s has a market-leading position in the Pizza industry with a brand value that can only be surpassed by McDonald’s in the fast-food industry. Expectations for Domino’s is to continue doing what it does best – opening new stores, increasing revenues and profit margins. In the past, we recommended investors avoid DMP. However, with the recent sell-off, which is an overreaction, the stock now trades lower than its fair value, and we recommend long-term investors to “Buy” a high-quality stock that dominates its market at the right price.

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