Leading analyst Sahill Shan has reiterated his Hold recommendation for Domino’s Pizza ahead of its H1 results next Tuesday, saying that he expects to see “robust” growth in the half year but the “jury is out” on the new management team.
Shan, of N+1 Singer Equity Research, said: “Interims next week are anticipated to show that the UK business remains in good shape. Nevertheless much of this is in the price.
“The focus for us will be more on the progress being made to address a number of key issues holding back the next leg of value creation. Positive tenor around these coupled with any forecast upgrades will be very well received. At this stage the jury is out on whether the new management team can deliver. For now we stay at Hold with a 12m TP of 535p based on a blended P/E and DCF analysis.”
Shan said he expects pre-tax profits to rise 11% to £24.7m. “We are anticipating strong UK LFLs of +9%. Q1 was +10.8% (vs. +6.6% comp) and for Q2 we are estimating +7.5% (+6.1% comp) driven by product innovation, stronger marketing and a World Cup uplift.”
“Domino’s is going through a UK evolution and getting to grips with an underperforming European business. In addition to this the jury is out on the new management team (CEO and FD) and to that end, it will be interesting to gauge what progress it is making in addressing the key drags on the investment case.
“The UK is fundamentally a strong business but there are two key issues that we will be focusing on next week. Firstly, how site expansion is progressing given previous admission that franchisee buy-in to the store in-fill strategy proved mixed in FY13.
“Management is keen to address this and we will be keen to see if there is any change to the UK new store guidance of 40-50 for FY14. Three stores opened in Q1 and there is some risk given a H2 weighted programme could lead to slippage. The second area is around the UK EBIT margin dynamic (N+1S FY14e +30bps). Management has flagged keeping gross margins flat to help readdress the fact that the economics had swung too far in favour of the PLC at the expense of franchisees in recent years.”
He said expansion into Germany has been “poorly executed”.
“For us the key areas of focus will be: (i) any change to FY14 German loss guidance of £5-7m (N+1Se -£6m) and a small loss for Switzerland (N+1Se -£0.2m); and (ii) what progress has been made in converting the remaining German corporate stores (eight) to franchisees (23 total stores at Dec-13), lifting LFLs (Q1 was subdued 3.2%) and driving greater franchisee expansion.”
Shan added: “The shares are admittedly well underpinned by the UK business being worth >550p on DCF analysis, thereby implying option value for International. A solid dividend and ongoing scope for capital returns provides further underpinning.
“To our mind however, the nub of the investment case is how successfully and quickly can the key issues outlined above be addressed. If new management succeed on this front then there is considerable potential for earnings growth and value creation.”
