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Morningstar | Domino’s Pizza Underdelivers Like-For-Like Sales Growth; Off to a Weak Start in Fiscal 2019

Domino’s Pizza certainly underwhelmed with weaker same-store sales growth and underlying net profit after tax than it had guided to, but sales and profit figures were broadly in line with our more cautious estimates. The miss against some investors' near-term expectations detracts from the long-term outlook, with the growth trajectory still intact, and leaves shares in narrow-moat Domino’s undervalued at current prices. The firm reiterated its store count goal for fiscal 2025, and we expect management to provide further guidance on store growth beyond 2025 in the coming months. We maintain our fair value estimate of AUD 53 per share, underpinned by the solid runway of new organic stores and continuing, albeit moderating, same-store sales growth for the group on a par with the global Domino’s business.

Underlying net profit after tax of AUD 133 million was slightly ahead of our AUD 131 million estimate, but far from reaching the guided number of about AUD 142 million. Sales growth in both Europe and Australia missed guidance and came in slightly below our estimates, but Japan surprised on the upside.

Management upgraded same-store sales growth guidance for Europe by 100 basis points in November 2017, only to miss the lower end of the range by 30 basis points. This reflected the significant impact of the unexpected spell of scorching hot weather across Europe in May and June on consumers’ appetite for pizzas. EBITDA margins in Europe were steady in fiscal 2018, but we expect these to gradually widen in the medium term, as synergy benefits following the German Hallo Pizza acquisition are realised, the new French leadership team establishes itself, and the business scales up significantly. In the first 34 days of fiscal 2019, European same-store sales grew by only 1.6%. We forecast European like-for-like sales growth of 4% for the full fiscal year, in line with guidance of 3%-6% growth, and total sales further boosted by 140 new stores opening.

In Australia and New Zealand, same-store sales growth of 4.5% was well below the bottom end of the guidance range of 6%-8%. However, this was more of an aspirational target after Domino’s reported weak comparable sales growth at the first-half results and exceeded our 5% growth forecast. So far in fiscal 2019, comparable sales have grown by 3.9% in Australia and New Zealand, ahead of our full-year forecast of 3%, and in line with guidance. EBITDA margins increased nevertheless, owing to the building scale of the business, as well as the derecognition of options costs. As the global business continues to grow, we expect the group’s overhead costs allocated to the Australian business to be further fractionalised, increasing EBITDA margins by another 400 basis points over the next decade. Australian franchisee profitability, a prerequisite for Domino’s to increase its domestic footprint, was steady in fiscal 2018 and for the year to date in fiscal 2019. This was despite an increase in wages, owing to the implementation of the Modern Fast Food Industry Award. Another indicator of franchisees’ continuing profitability is that virtually all new Australian stores were opened by existing franchisees or store managers who should be well aware of store financials.

Japanese same-store sales rebounded from a weak first half, eking out 0.9% growth for fiscal 2018, and beating our estimate of flat comparable sales. Also, the first 34 days impressed with comparable sales growth of 12.0%. However, sales may have been pulled forward in a market where pizza consumption is relatively low , and we conservatively estimate the full-year same store sales growth rate at 1% in fiscal 2019. As expected, the ownership of stores by franchisees is increasing relative to corporate stores, but this is happening sooner than expected. Currently, 42% of the Japanese store network is franchised, against the target of at least 40% by fiscal 2020. We expect this trend to reduce capital intensity and underpin EBITDA margin expansion to 18% from around 13% currently.

For the group, we forecast like-for-like sales growth of 3% and 220 net new store openings in fiscal 2019, compared with guidance of 3%-6% and 225-250 stores, respectively.
Domino’s medium-term comparable sales growth outlook is in line with the expectations of its master franchisor, Domino’s Pizza Inc, of international same-store sales growth in the range of 3%-6%.