Domino's Pizza: A tremor in Japan

About the author:

Alexander Mees
Author name:
By Alexander Mees
Job title:
Co-Head of Research and Senior Analyst
Date posted:
05 November 2021, 7:30 AM
Sectors Covered:
Gaming and Retail

  • We have lowered our NPAT forecast for FY22 by 11% to $201.6m following Domino's Pizza's (ASX:DMP) AGM trading update.
  • Although same-store sales (SSS) growth in the first 18 weeks of FY22 was stronger than expected at +4.3%, there has been a rapid slowdown in sales in Japan since reopening on 1 October that has caused DMP to warn that it may not achieve positive earnings growth in that country this year.
  • DMP trades at an elevated multiple of near-term earnings, which reflects its superior long-term growth prospects. In our opinion, this unexpected speed bump in Japan is transitory and does not imply any material change to those prospects. That said, DMP is not scheduled to give any further update to the market until the interim results in February.
  • This is a long time to wait to see how much of the ground lost in Japan has been regained. Given earnings multiples are still high despite this morning’s correction, we stick with a Hold for now.

Customer ordering patterns have changed markedly in Japan on reopening

The lifting of the State of Emergency in Japan on 1 October 2021 has led to a more pronounced change in customer ordering patterns than DMP had anticipated. The company’s experience in Japan has been quite different from its experience during the recent period of reopening in Europe.

In Europe, delivery customers acquired during the pandemic have largely stayed with DMP, despite the reopening of restaurants, shopping centres and bars during the summer. In Japan, however, a section of the customer base that came across to DMP during lockdown appears to have reverted back to out-of-home venues and not (yet) returned in significant numbers. This dynamic appears to be widespread throughout the food service industry and is not unique to DMP. 

In our opinion, this does not imply that DMP’s model is not working in Japan. Nor does it suggest the strategy of rapid store rollout and ‘fortressing’ has lost any of its validity.

What is does mean, however, is that last year’s stellar performance in Japan may have been more positively affected by the pandemic than we (and DMP) had thought. This has negative connotations for near-term earnings in Japan and we have reflected this in our updated estimates.

What must also be remembered today is that DMP’s business outside of Japan is performing very well. As mentioned above, European delivery activity has not fallen away post-reopening and carryout sales are starting to rebuild.

We believe the picture is similar in Australia and New Zealand, despite the logistical challenges presented by lockdown in certain areas. DMP said that it ‘anticipates some inflationary headwinds’ including energy and soft commodities in 2022, but its supply chain is geared to adapt to these and improved store efficiencies and higher unit sales should ‘offset short-term inflation’.

Store rollout aspirations remain very much intact

DMP has reiterated that it expects to see a record number of new stores added to its network in FY22. The previous record was 484 store additions in FY16, which included the acquisition of Joey’s Pizza in Germany and Sprint Pizza in France.

DMP’s recent acquisition of Taiwan brings with it 156 new stores. This implies DMP is targeting at least 328 organic store openings this year, representing 11% of its store count at the end of FY21, which is towards the top of its medium-term target range (9-12%). DMP will reap the benefits in future years.

DMP has also said that it is ‘active’ in its pursuit of new markets. DMP currently operates in ten countries around the world. Five of those countries are ‘primary’ markets. We believe DMP is keen to add both primary and secondary markets and has the blessing of DPZ in the US to explore opportunities.

Forecast and valuation update

We had previously forecast 15% EBITDA growth in Japan in FY22. We have now lowered this estimate to a 4% decline.

We now forecast group EBITDA of $452.7m (down 6.9% from $486.3m). Our EBIT estimate falls 10.1% from $352.5m to $316.7m and NPAT after minorities declines by 11.3% from $227.3m to $201.6m.

Investment view

Unless there is an acquisition, DMP is not expected to talk to the market again until the interim results in February.

Given the uncertainties around the trajectory of sales in Japan, we retain a Hold rating for now, with a reduced target price of (login to view).

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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