RESEARCH NOTE Domino s Pizza -Buy

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Marsha Watson
5 years ago
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1 1 RESEARCH NOTE Domino s Pizza -Buy Price: A$41.50 Price Target: $47.50 ASX: DMP 16 August 2017 DMP's share price plunged -19% (and was down as much as -21%) after the Company s FY17 results missed market expectations on nearly every measure. Interestingly, the Company missed its own guidance which it revised up during the year. The miss was driven by Europe (namely France), store rollout coming in at the lower end of guidance and soft trading conditions in Japan.FY18 outlook also disappointed the market, with FY18 NPAT expected to grow by approximately +20%. This implies A$142.2m on underlying basis, which is -11.9% below current market expectations of A$161.5m. Among the results, DMP also announced a A$300 million onmarket buyback given the under-geared balance sheet. We initiate with a Buy recommendation on significant share price weakness. While it remains to be seen whether some of the issues that led to the profit guidance miss are permanent or not, we believe the risk/reward looks more palatable at current levels. We are not calling the bottom of the share price (the stock may be in a trading range while investors fully come to terms with the drivers) however we expect the buyback to provide some share price support. After the share price decline, on our estimates, DMP is trading on 21x FY19e PEmultiple and yield of 3.7%. FY17 results came in below DMP s upgraded guidance.(1) ANZ s same store sales (SSS) of +13.6% missed guidance of 14-16%; (2) Europe SSS growth of +2.8% was well below

2 2 guidance of 5-7%; (3) Japan SSS declined -0.6% versus guidance of 0-2%; (3) new store additions of 178 were at the lower end of guidance of ; (4) operating earnings (EBITDA) grew by +28.3%, which was well below guidance of approximately +32.5%; and (5) NPAT growth of +28.8% was below guidance of approximately +32.5%. France was the culprit. Management noted on the analysts conference call that the Australia and New Zealand businesses were tracking in line with expectations, even though same store sales were a little softer. However, it was Europe, driven by France, which led to DMP missing its earnings guidance. European same store sales growth moderated to +2.5% versus +8.0% achieved in second half of FY16. Management called out the following drivers for challenging French sales: technical customisation issues with One Digital (4 months delay); new value message failed to resonate with customers and had to be adjusted; comparable prior period had the 2017 UEFA Euro Championship. The first two issues now have been resolved, with first 6 weeks of same store sales in Europe up +8.8%. Buyback announced putting the balance sheet to work. The Company will buy back A$300m shares over a 12-month period commencing from 29 August The rationale given for the buyback was the strength in DMP s cash flow and balance sheet, with current gearing of 1.2x (net debt / EBITDA) comfortably below target range of 2-3x. Management also noted that the announcement of the buyback does not stop the Company making value accretive acquisitions should they arise. Whilst we get the lazy balance sheet argument, we are still surprised why the Company wants to conduct an on-market buyback of its stock, which is trading at high multiples. We note specifically for the employees within the ANZ segment and CEO Don Meij option vesting performance conditions are linked to DMP s EPS percentage growth over the relevant performance period. In any case, the on-market buy back should provide share price support. FY18 guidance and current trading update. DMP sfy18 outlook also disappointed the market, with FY18 NPAT expected to grow by approximately +20%. This implies A$142.2m on underlying basis, which is -11.9% below current market expectations of A$161.5m. The guidance also implies moderating sales growth in ANZ and significant slowdown in NPAT growth. Specifically: (1) SSS growth in ANZ is expected

8%;(3) SSS growth in Japan is expected between 0-2% vs FY17-0.

3 3 between 7-9% vs FY %;(2) SSS growth in Europe is expected between 5-7% vs FY %;(3) SSS growth in Japan is expected between 0-2% vs FY17-0.6%; (4) net store additions of vs FY17 178; and (5) NPAT growth of approximately +20% vs FY %. FIGURE 1: DMP REVENUE BY REGION FIGURE 2: DMP EBITDA BY REGION

4 4 Investment Thesis We rate DMP as a Buy due to the following reasons: Potential for solid growth in Europe and Japan, substantial opportunities, that the Company is positioned to take advantage of. FY18 trading update suggests same store sales (SSS) is positive, apart from Japan. DMP is ahead of the curve with the use of technology and innovative offerings for its customers. Acquisition in Europe to bring in top line revenue growth. A$300m on-market share buyback to provide share price support. FY18 guidance may prove conservative, given management is now likely to set the benchmark low after the FY17 earnings miss. Strong management team. Key Risks We see the following key risks to our investment thesis: Acquisition integrations not going to plan. Missing market expectations on sales and earnings growth. Dietary concerns that drive customers to healthier alternatives. Increased cost in ingredients and labour. Market pressures from the competition. Departure of key management personnel. Corporate office having to increase financial support to struggling franchisees. Any negative media articles especially around underpayment of wages at the franchisee level.

5 5 Any emerging concerns around store rollout (such as cannabalisation or demographics not supportive of new stores). Company Description Domino's Pizza Enterprises Limited (DMP) operates retail food outlets. The Company offers franchises to the public and holds the franchise rights for the Domino s brand and network in Australia, New Zealand, Europe and Japan. FY17 Results Summary FIGURE 3: DMP FY17RESULTS SUMMARY KEY NUMBERS

6 6 FIGURE 4: DMP FINANCIAL SUMMARY

7 7 Disclaimer/Disclosure This document is provided by Vested Equities Pty Ltd (ABN ; AFSL ) ( Vested ). The material in this document may contain general advice while believed to be accurate at the time of publication, are not appropriate for all persons or accounts. This document does not purport to contain all the information that a prospective investor may require. The material contained in this document does not take into consideration an investor s objectives, financial situation or needs. Before acting on the advice, investors should consider the appropriateness of the advice, having regard to the investor s objectives, financial situation and needs. The material contained in this document is for information purposes only and is not an offer, solicitation or recommendation with respect to the subscription for, purchase or sale of securities or financial products and neither or anything in it shall form the basis of any contract or commitment. This document should not be regarded by recipients as a substitute for the exercise of their own judgment and recipients should seek independent advice. The material in this document has been obtained from sources believed to be true but neither Vested nor its associates make any recommendation or warranty concerning the accuracy, or reliability or completeness of the information or the performance of the companies referred to in this document. Past performance is not indicative of future performance. Any opinions and or recommendations expressed in this material are subject to change without notice and Vested is not under any obligation to update or keep current the information contained herein. References made to third parties are based on information believed to be reliable but are not guaranteed as being accurate. Vested and its respective officers may have an interest in the securities or derivatives of any entities referred to in this material. Vested does, and seeks to do, business with companies that are the subject of its research reports. The analyst(s) hereby certify that all the views expressed in this report accurately reflect their personal views about the subject investment theme and/or company securities. The securities of any company(ies) mentioned in this document may not be eligible for sale in all jurisdictions or to all categories of investors. This document is provided to the recipient only and is not to be distributed to third parties without the prior consent of Vested. We disclose that Vested Equities Pty Ltd, it's directors and advisers have investments in this company. Before investing, you must consider the Prospectus, including the risks that are outlined in that document, before applying for any shares under the IPO offer. To apply for shares you must complete the online Application Form that accompanies the Prospectus. The above dates are indicative only and are subject to change. The Company reserves the right to vary the dates and times of the Offer, including extending the Offer or accept late Applications, without notifying any recipient of this Prospectus or any Applicants. Applicants are encouraged to submit their Applications and payment as early as possible.

INDEPTH RESEARCH NOTE REA Group Ltd Neutral

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