Domino’s Pizza Enterprises has disappointed investors over the past couple of years, after its long stellar run came to an end. One fund manager had recently added it to its portfolio.
Domino’s was a market darling, much loved by fund managers with a preference for growth stocks. At the end of 2013 its share price was sitting around $10, having doubled over the previous couple of years.
Then the share price took off, eventually reaching a peak of $75.80 in August 2016.
Cracks started to appear at that point. The company suffered bad publicity over accusations underpayment of wages by its franchisees.
It missed earnings guidance when it announced its 2016/17 results and flagged relatively weak earnings growth for 2017/18. The business was maturing and some of its forecasts were being shown to have been overly optimistic.
By April 2018, the share price was down to $40.43 and, after a brief recovery, it fell to $38.43 in June this year.
DNR Capital has been a buyer for its Australian Equities High Conviction Fund, saying the business has a number of attractions. It still has a strong brand and is a market leader. Its franchise model means it does not need a lot of capital.
“Domino’s Pizza Enterprises and its franchisees are market leaders in profitability, return on capital and margins,” DNR says in a recent investor report.
It believes the number of stores acts as a barrier to entry for other pizza operators.
Even though it has suffered some reputational damage, it is still able to attract franchisees, who are drawn to the comparative performance of the stores.
Finally, DNR thinks the company’s opportunity in Europe looks good. It is in the early stages of rolling out a store network, currently focused in Germany and France, which should extend the growth it has enjoyed in Australia.
DNR also likes the look of the management team and the company’s balance sheet. A low level of debt has the double benefit of reducing risk in a cyclical industry and providing firepower for acquisitions.
It says the company ranks low for ESG risks.
It acknowledges that an investment in Domino’s is not risk-free. Franchise regulation may be toughened up, following recommendations of a Parliamentary review of the sector earlier this year.
Franchisees are not a profitable as they once were, thanks to higher wages and higher energy costs. Domino’s volumes may increase in the local market but its margins are likely to remain flat.
Future growth is tied to a successful rollout in Europe and Japan, which is not yet a certainty.
DNR says: “Domino’s trades in line with the industrial average PE, despite double-digit growth. The valuation looks especially attractive as you look out a couple of years.”