Looking back at the detail of Domino’s Q1 update early this month, analysts at Berenberg believes a cocktail of conditions is creating a very uncertain long-term outlook.
The note from Berenberg said that Domino’s Pizza’s “poor” Q1 2019 trading update showed that it continues to suffer from all of the problems it highlighted when it downgraded the stock to Sell.
“Lfl growth in the UK is proving tough to come by, the difficult relationship with franchisees remains unresolved and the performance of the international division has deteriorated further,” they stated. “We believe these issues could continue to put pressure on near-term earnings, while aggressively expanding competitors create a very uncertain long-term outlook.”
Underlying UK growth subdued
“Domino’s generated just 3.1% UK lfl growth (excluding store splits) in Q1. While the company highlighted this maintained a consistent pace of two-year lfl growth, on a three-year basis – which includes the poor performance during the first few months of 2017 – underlying growth slowed materially. Furthermore, lfl volumes fell 2.7% during Q1. Although part of this was due to a free pizza promotion in early 2018, underlying volumes still declined.
“This is an issue both because driving lfl growth through price may not be sustainable and because lower volumes will hit the company’s supply-chain centre sales. We do not change our 2019 UK lfl growth forecast at this stage, but we do think there is some downside risk (although we note comps are soft in Q2), and we have reduced our supply-chain centre revenue estimate slightly.”
Expansion slowing
“Domino’s Pizza’s UK openings programme has almost ground to a halt during 2019. Even including two new corporate stores, only seven sites were added and one was closed in the first 18 weeks of the year. This clearly demonstrates that the company is struggling to convince franchisees to open new shops while the dispute surrounding commercial terms continues.
“In our view, it is unlikely that the rate of site additions will return to anything close to management’s target of c80 new stores pa until the economics for franchisees improve, which could require changes that have a substantial impact on Domino’s Pizza’s profit or cash flow.”
International woes continue
“Despite Domino’s establishing in-country management teams for the overseas business and identifying key areas of improvement for each county, lfl sales declined in Iceland, Norway and Switzerland in Q1.
“As a result, the company has already given up on its target for the international division to return to breakeven in 2019 and suggested the loss could even be greater than last year’s. Domino’s Pizza’s overseas challenges are significant and varied, so we believe the difficulties could persist for some time.”
Valuation: Domino’s trades on 14.5x 2019E P/E and 11.5x EV/EBITDA.
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