Peel Hunt analysts Douglas Jack and Ivor Jones have given their views on the outlook for Domino’s Pizza, stressing that the current share price underestimates the long-term expansion potential, and over-estimates the short-term downside risk from fewer store openings.

The note says: “Domino’s Pizza Group (DPG) has the most profitable franchisees in Domino’s worldwide network. Although their average store profit doubled between 2013-17, some of them want even better buying terms. We believe all the board back the company standing firm; the alternative could potentially expose the company to a continuous stream of further demands in the future.

“The only leverage the franchisees have is to not open stores. This is not a big concern; each store opening affects full-year PBT by c£0.085m, less than 0.1% of PBT. If DOM misses its MFA target of 1,346 stores by 2026, we believe that it would only lose the 30bps royalty discount in seven years’ time.

“The performance of new stores was the key takeaway from the CMD. New store sales are up 38% over the last six years despite a 19% decline in addresses per new store. Without reducing average sales, lower address counts mean the stores are closer to the customers, reducing delivery times; this boosts reorder frequency and lowers labour costs through reducing driving distances and raising collection ratios. All this is great for franchisee margins.

“Higher leverage. When franchisees split stores, cash returns at maturity fall from nearly 50% to almost 40% for the two sites combined. However, their return on equity can be even higher given that franchisees typically borrow 90% (£290k) of the £325k cost of new stores.  Domino’s has multiple opportunities to drive up average spend per address. These include targeting higher lunchtime sales, increasing the collection ratio and using CRM to engage with less active customers. Our forecasts assume that system sales grow by just 6.6% in 2019E and 4.7% in 2020E despite the company aspiring to grow sales at 8%, in line with the food delivery market.

“Our forecasts assume LFL sales growth of just 2.5% in 2019E and 2.0% in 2020E (vs an 8% historical average) and estimate that each extra 1% of system sales is worth £0.9m of PBT. For a long-term franchised growth model, the valuation is too low in our view.”