Domino's Pizza: 1H22 result - a marginal miss

About the author:

Alexander Mees
Author name:
By Alexander Mees
Job title:
Co-Head of Research and Senior Analyst
Date posted:
24 February 2022, 11:30 AM
Sectors Covered:
Gaming and Retail

  • Domino's Pizza's (ASX:DMP) 1H22 result disappointed on operating margins, with its profitability in Asia under-performing expectations. This represents a reset of Asian margins after the COVID tailwinds of last year, but we believe margins will improve in the months ahead as the rush of new corporate stores matures.
  • We have lowered EBIT forecasts by 5% for FY22 and 4% for FY23.
  • DMP remains a growth story. It has a platform to deliver a positive trajectory of sales and earnings as its store rollout strategy continues and network efficiencies increase. After a period of sustained weakness in the share price, we think now is the time to give DMP another look. We upgrade to ADD.

Event

DMP reported EBIT of $144.7m down 5% and 7% below our estimate. Sales held up better than expected in Asia, but a ‘rebasing’ of store economics after last year’s tailwinds meant the region’s margins were short of expectations.

Overall network sales were up 11.1%, 2.3% above our estimate. This included same-store sales (SSS) growth of +2.8%. The group EBIT margin of 12.0% was 200 bp lower than 1H21 and 110 bp below our forecast.

Analysis

Asia ‘rebases’ after last year’s COVID tailwinds

DMP has been rolling out new corporate stores in Japan aggressively in recent months. This has given it good coverage of the country in a short space of time (it’s now in 47 prefectures and is the number 1 player in 23, including Tokyo and Osaka).

The COVID-related State of Emergency bolstered consumer demand, accelerating the maturity profile of many of these new stores and pushing up margins. The ‘normalisation’ of customer behaviour after the State of Emergency was lifted has seen store economics ‘rebase’. This had a more pronounced effect on margins in Asia than we had anticipated, which fell from 14.3% in 1H21 and 14.4% in 2H21 to 10.3% in 1H22.

We don’t expect margins to snap back immediately, we do expect them to improve in the months ahead as stores matures and network efficiencies increase.

Long-term store milestone targets reiterated

DMP remains confident of adding 500+ stores to its network in FY22 (we are a bit more cautious at 486). It upgraded its 2033 milestone targets at the FY21 result and reiterated those milestones today. Projecting 6,650 stores by 2033, double today’s 3,227, speaks volumes. 

Forecast and valuation update

We have reduced our EBIT forecast for FY22 by 5% to $301.5m and for FY23 by 4% to $364.4m. This is mainly a function of a 70 bp reduction in forecast EBIT margin in FY22 to 12.1% and a 60 bp reduction in FY23 to 12.9%. This compares to the FY21 EBIT margin of 13.3%. Our EPS estimates also fall by 5% in FY22 and by 4% in FY23.

Our target price, which is the average of our DCF and EV/EBITDA valuations, declines by 15% due to our estimate revisions and reduced peer company EV/EBITDA multiples.

Investment view

We forecast DMP to deliver an 18.0% 5-year cumulative average growth rate of EPS between FY20 and FY25F. We expect this to be achieved through a combination of steady SSS growth (average of +4.5%, FY20-25F); organic store rollout (average of 297 per year, FY20-25F); and the inclusion of the new market of Taiwan.

DMP also has the financial and operational capacity to seek further acquisition opportunities, as well as the approval of DPZ to do so.

DMP has de-rated substantially from a high of $165 in September last year to close at $86 today. Even after the de-rating, it remains a premium multiple stock, but in our opinion the growth potential of the business warrants this status. ROIC is set to accelerate in the years ahead.

We think investors should take their opportunity to build a position in this high quality business at the current attractive entry point. We upgrade to ADD.

Price catalysts

Catalysts include evidence of scale benefits coming through; RBA cash rate increases; large client wins (FUA transition); and acquisitions.

Risks

Further declines in the EBIT margin of the business in Japan would put pressure on our estimates.

Failure to mitigate cost inflation, especially around food, energy and labour.

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