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 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 175-195; (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 2017. 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
3 between 7-9% vs FY17 +13.6%;(2) SSS growth in Europe is expected between 5-7% vs FY17 +2.8%;(3) SSS growth in Japan is expected between 0-2% vs FY17-0.6%; (4) net store additions of 180-200 vs FY17 178; and (5) NPAT growth of approximately +20% vs FY17 +28.8%. FIGURE 1: DMP REVENUE BY REGION FIGURE 2: DMP EBITDA BY REGION
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 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 FIGURE 4: DMP FINANCIAL SUMMARY
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