Domino's Pizza: FY21 result - If only the shares were as good value as the pizzas
About the author:
- Author name:
- By Alexander Mees
- Job title:
- Co-Head of Research and Senior Analyst
- Date posted:
- 19 August 2021, 9:00 AM
- Sectors Covered:
- Gaming and Retail
- Domino’s delivered very strong network sales and margin expansion in FY21, leading to earnings that were slightly above consensus expectations. Same store sales growth was 9.3%, with especially strong performances in Europe and Japan.
- Domino’s increased its targets for network expansion and lifted its dividend payout ratio to 80%. With very strong cash generation and a robust balance sheet, we believe Domino’s can fund the dividend, capex and anything other than a large acquisition through existing balance sheet capacity. An investment in Domino’s brings with it a very compelling long-term growth story.
- The super-premium valuation keeps us at a HOLD recommendation, but this is a stock we would look to buy on any sort of weakness in the share price. With this note, coverage of Domino’s Pizza Enterprises transfers to Alexander Mees.
Growth running hot through FY21
Network sales grew 18.8% in constant currency terms, driven by 9.3% same store sales (SSS) growth and network expansion. Domino’s added 285 stores to the network in FY21, including 129 in Europe and 126 in Japan.
Consumer demand for Domino’s product remained strong through the pandemic and does not look likely to diminish now. FY21 EBITDA was $424.9m, 1.4% above Factset consensus ($419m) and 2.9% below MorgansF ($437.8m). EBIT was up 27% to $293.0m.
The top-line growth flowed through to positive operating leverage and supply chain efficiencies leading to a 130 bp margin expansion to 13.3%.
Store rollout targets increased
Domino’s upgraded its target for annual organic store additions over the next 3-5 years from 7-9% of the network to 9-12% of the network. From a store count that is currently just short of 3,000, the group expects to open its 4,000th store in CY23 and its 5,000th store in CY26-27.
And who would bet against it? Domino’s remains underpenetrated in many of its key markets and has a very strong track record of increasing store density while maintaining (and improving) store economics.
Increased store rollout assumptions drive a 4% increase in our EPS forecast for FY22 and a 3% increase in our EPS forecast for FY23.
Impressive FCF and ROCE underpins lift in dividend payout
Free cash flow (after lease principal payments) increased by 40.2% to $216.2m, or $2.50 per share. Domino’s business model is based primarily on franchises, which allows it to drive strong growth without excessive capital investment.
Cash conversion (105.7% in FY21) and ROCE are high (18.7% in FY21).
Choose your moment
It isn’t hard to construct a positive investment case for Domino’s Pizza. The prospect of steady, maybe even accelerating, network expansion, combined with the high returns and cash generating capacity of the franchise model are very attractive to investors seeking a growth story that also has elements of economic resilience. But, as fundamental analysts, we cannot disregard valuation.
Assessing the valuation solely through the lens of a 50x FY22F P/E price tag perhaps isn’t the most useful strategy in light of the long-run growth potential of the business.
Fundamental techniques such as DCF are, in our opinion, more helpful. But even applying a 7.3% and 4% terminal growth rate to our DCF model returns a valuation of $152.74 and our price target (which is a blend of both DCF and multiple-based valuation techniques) to (login to view).
With the shares closing last night at $136.00, there isn’t enough upside to our price target for us to say now is the time to buy. But that time might come. The shares rose 6% on the day of the 1H21 results back in February, but then retreated 22% (all the way down from $110.09 to $86.30) over the following three weeks.
Were something like that to happen again as investors take profits, we’d be buying DMP below $120 faster than it takes to order a Loaded Pepperoni.
Risks to our view
Our rating will be too conservative if Domino’s materially exceeds our 3.5% SSS growth forecast in FY22.
Our rating will be too optimistic if SSS growth falls short or if cost pressures impact the margin.
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