Domino's Pizza: 1H23 earnings - Shaken and stirred

About the author:

Alexander Mees
Author name:
By Alexander Mees
Job title:
Co-Head of Research and Senior Analyst
Date posted:
23 February 2023, 6:30 AM
Sectors Covered:
Gaming and Retail

  • Domino's Pizza (ASX:DMP) disappointed the market with 1H23 EBIT that fell 5% short of our forecast and 7% short of consensus.  Recent trading has stalled as customers push back against higher prices, causing DMP to walk away from its SSS growth target for the year.
  • We have lowered our FY23 EBIT forecast by 12% and FY24 by 15%.
  • Our target price falls from (login to view). We have maintained an Add rating.

Result synopsis

Just when it appeared DMP was starting to come through the various headwinds that have affected it in recent months, the 1H23 result provided an unwelcome reality check.

Revenue was only 0.7% below our forecast, but margins failed to recover at the pace we expected and EBITDA was 4.1% below our forecast and 5.9% below consensus at $182.3m. EBIT was 5.4% below our forecast at $113.9m.

The EBITDA margin was 15.1% (MorgansF: 15.6%) and the EBIT margin 9.4% (MorgansF: 9.9%). Despite its same store sales (SSS) growth getting back into positive territory, Europe was again the primary area of earnings weakness as its EBIT margin contracted from 8.5% in 2H22 to 7.0% in 1H23. Group NPAT was $71.7m, down 21.5% (or 16.7% excluding FX), 5.2% below our forecast.

The dividend was 11% below forecast at 67.4c. DMP opened only 79 organic new stores in 1H23 and said it may miss its 8-10% network expansion target in FY23.

Morgans comment #1: Sales stalled

Group SSS was a decline of (0.6)%, below our forecast of (0.3)% and consensus of +0.8%. The group number was dragged down by Asia, which was (6.6)%, although ANZ disappointed us with just +1.7%.

More concerning, though, was that sales, though positive, were ‘significantly below expectations’ in December. SSS then turned (2.2)% negative in the first 7 weeks of 2H23. This caused DMP to concede it would not hit its target of +3-6% SSS growth in FY23, despite having reiterated this target several times this year.

We have lowered our estimate from +3.0% to (0.4)%. What went so wrong? DMP has been pushing through higher prices and surcharges (like delivery charges) to protect its margins and those of its franchisees, in the face of strong commodity and labour cost inflation.

The customer did not take well to the increases, however, and while unit economics initially appeared to benefit from the price hikes, customer repurchasing fell away, causing sales to stall and leaving DMP with the challenge of enticing customers back while offsetting ongoing high input costs. This won’t turn around quickly.

Morgans comment #2: European margins under pressure

It is very hard to achieve operating margin expansion when sales are in decline. It is doubly hard when cost inflation is rampant, as it is in Europe and especially in Germany and France.

The group EBIT margin in 1H23 was 260 bps lower than the PCP, with European margins halving from 13.8% to 7.0%, which was 150 bps lower even than 2H22. The EBIT margin did increase in ANZ (from 15.0% to 15.7%) and fell by just 90bps in Asia to 9.4%.

The circuit breaker to the margin decline in Europe was supposed to be higher selling prices, but the customer pushback to this means a rethink is required. Group EBIT was $113.9m in 1H23, 1.5% lower than in 1H20, before the onset of COVID.

DMP did point out that the 1H23 was net of three significant headwinds – the step-up in the German royalty ($4.5m), the ‘investment’ in Denmark ($4.9m) and adverse FX movements ($8.2m). Had it not been for these, EBIT would have been $131.4m or 13.7% higher than 1H20. This is cold comfort. It should have been higher.

Changes to earnings estimates

We have elected not to give DMP the benefit of the doubt when it comes to a rapid turnaround in fortunes.

We have lowered our EBIT forecast for FY23 by 12% to $237m, based on the assumption that the group EBIT margin will grow only from 9.4% in 1H23 to 10.3% in 2H23 (60 bps below 2H22). We assume (0.1)% SSS growth in 2H23. We have lowered our EBIT estimate for FY24 by 15% to $277m.

We forecast 160 organic new stores in FY23 (4.7% network expansion).

Investment view

Despite the evident disappointment of the 1H23 result, we had anticipated this result could be a negative one for sentiment.

We didn’t expect the shares to fall as much as they did, however, and even with significantly lower earnings estimates for FY23 and FY24 and a significantly lower target price, there is enough upside to our target to keep us on an Add. But our faith is shaken.

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