Home / Opinion / Buy, Hold or Sell: Domino’s Pizza (ASX: DMP)

After initially soaring as high as $161, the Domino's Pizza Enterprises (ASX: DMP) share price has crashed back to earth. So why has the market turned sour on Domino's?

After initially soaring as high as $161, the Domino’s Pizza Enterprises (ASX: DMP) share price has crashed back to earth. The former market darling now trades at $60, coincidentally in line with its pre-pandemic share price.

In those two years, network sales have increased 29%, earnings are up 26% and online penetration jumped 41%. The growth outlook for Domino’s remains positive. Management plan to grow the store network by 9-12% per annum over the medium term, in addition to 3-6% growth expected from the existing stores. It’s not onerous to forecast 12% top-line growth for the foreseeable future. The business also recently added Taiwan as its tenth country under the group’s umbrella.

So why has the market turned sour on Domino’s? Part of it has to do with the recalibration of growth companies, which most agree got ahead of themselves when interest rates were pegged at zero. The market is also concerned that the company was over earning during the pandemic, with sales to retrace as in-person dining returns. Subsequently, growth in FY22 will look less impressive as it cycles an elevated prior-year result.

However, the biggest investor concern is currently inflation. Evidence of rising costs appeared in the most recent half-year result. ANZ increased sales by 5.2% but regional earnings fell by 6.1%. In Asia, sales increased 14.3% yet earnings fell 17.3%. Some of the reduction in Asia is attributable to store network expansion, with less mature stores weighing on profits. Nonetheless, management has highlighted inflation as a near-term headwind.

Competitor Yum Brands (franchisor of Pizza Hut, Taco Bell and KFC) restaurant margin fell 9% citing inflationary pressures. Chipotle noted 12-14% food inflation across its business. While Mcdonald’s said wages were up 10% due to labour constraints.

Keeping revenue constant, if food and wages were to rise 10% at Domino’s, profit would fall by 46%. Even just a 5% increase in the two expense lines would reduce profit by 24%. Domino’s could counter inflation by simply raising prices. For example, a 5% increase in wages and food costs could be offset with a 3% price rise.

However, instead of simply rising prices as its competitors have, management has chosen to adopt a “more for more” approach. New menu items (bundles, sizing, extra toppings) have been added that provide more value for the customer while maintaining margins via a small price increase. So far so good, with positive feedback from franchisees. The Value Max range accounted for 23% of sales in the first half.

It’s also worth mentioning that should inflation persist, it may end up being a net positive for Domino’s. Lower disposable income means families substitute dining out at restaurants for cheaper take-out alternatives. Domino’s is largely considered the cheapest way to feed a family of four.

Of the analysts that cover Domino’s and have updated modelling in June, the consensus share price is $92.80 implying a 50% upside from today’s prices. Analysts like the long-term growth opportunity, offset by the near-term inflationary and currency pressures.

Domino’s currently trades on a forward earnings multiple of 26, which is below its ten-year average of 34. Historically the business traded no lower than 20. For investors willing to take a long-term view, today represents compelling value. However given the uncertainty over the impact of inflation on its earnings, a conservative investor should wait for management to provide more colour at the upcoming full-year result in August.

Information warning: The information in this article was published by The Rask Group Pty Ltd (ABN: 36 622 810 995) is limited to factual information or (at most) general financial advice only. That means, the information and advice does not take into account your objectives, financial situation or needs. It is not specific to you, your needs, goals or objectives. Because of that, you should consider if the advice is appropriate to you and your needs, before acting on the information. If you don’t know what your needs are, you should consult a trusted and licensed financial adviser who can provide you with personal financial product advice. In addition, you should obtain and read the product disclosure statement (PDS) before making a decision to acquire a financial product. Please read our Terms and Conditions and Financial Services Guide before using this website. The Rask Group Pty Ltd is a Corporate Authorised Representative (#1280930) of AFSL #383169