Sandstone Insights: Domino’s Pizza sees potential upside with aggregators and store rollout changes

ASX code: DMP

Suggestion: Hold

Need to know

• Aggregators can help to lift same-store sales growth and DMP franchisee profitability
• The pace of new store rollouts will likely slow down
• Consensus expectations for sales growth and margins are too high in the near term
• We upgrade DMP to Hold. Evidence of improved sales performance is a key catalyst for the share price.

Role of aggregators and sales growth

An investor tour to Germany and France has provided insight into the role of aggregators as a complementary delivery method that can support sales growth. Domino’s Pizza (ASX: DMP) has issues to resolve in France and Japan, but elsewhere, same-store sales growth (SSSg) is beginning to improve, despite new store rollout and lower margins remaining as headwinds. Consequently, the recommendation has been lifted to Hold from Sell.

Aggregators such as Uber Eats, Menu Log, and Deliveroo have become indispensable to DMP’s business. While many quick-service restaurant (QSR) businesses resist aggregators due to margin impacts, evidence suggests that aggregators help increase order numbers and sales growth. Online food aggregators account for 36% of digital sales in Germany, 27% in the Netherlands, and just 10% in France. DMP notes that Europe has over 20 years of experience with order aggregators, where characteristics differ from traditional direct customer orders. Crucially, DMP asserts that aggregator customers are incremental and profitable, needing optimal development.

Regional metrics and franchisee profitability

The European market for DMP (Benelux, France, and Germany) has varied metrics. DMP’s market share in Benelux is 34% compared with 8% in France. Franchisees in Germany are levied 6% of sales for marketing, versus 4% in France and 5.5% in Benelux. These variations result in wide EBIT margin disparities: France at 0.7%, Germany at 6.2%, and Benelux at 5.0% in FY24. Estimated franchisee profitability is significantly lower in Europe compared to Australia.

Store rollout strategy

DMP is targeting 2,900 stores across Europe (currently 1,400), 3,000 across Asia (1,532), and 1,000 in Australia (900). However, this target may take up to ten years to achieve, longer than previously expected. DMP’s sales formula targets 3-6% SSSg combined with 7-9% store growth, adjusted from 9-12% in 2022. Achieving these targets by 2033 would require 10-15% network sales growth annually, which is ambitious. Extending the store rollout timeframe by ten years would necessitate a 3-5% store growth annually, lowering the sales growth target to 5-9%.

Group-wide franchisee profitability, measured as EBITDA per store, was AUD 95k in 1H24, compared to a target of AUD 130k needed to stimulate new store openings. Franchisee profitability per store is estimated at AUD 130k in Australia, AUD 80k in Germany and the Netherlands, and about AUD 70k in France and Asia.

DMP has a high-volume mentality, driving sales on the basis that incremental margins are very high. Using aggregators to increase order counts should improve franchisee profitability, although incremental sales on such orders would have lower margins. On average, each DMP franchisee has 2-3 stores, with a medium-term target for franchisees to have 10 stores each. Achieving this requires strong and growing franchisee profitability.

Investment view

The European investor trip highlighted the importance of aggregators to lift sales growth and franchisee profitability, which remains low compared with Australia. It seems clear that DMP’s weak sales growth in recent times can improve through better use of aggregator channels, logically leading to improved franchisee profitability—a key weak point in the investment thesis for DMP.

DMP is realising that a more localised approach can be combined with its globally consistent model to generate better sales growth, particularly necessary in France.

We expect DMP will place less emphasis on new store rollouts, especially in Japan, and greater importance on improving franchisee profitability as a precursor to store growth.

Improving sales growth

Same-store sales growth (SSSg) in 1H24 was a meek 1.3%, although the growth rate is improving in 2H24. Consensus estimates for the next three years anticipate an average SSSg of 3.5%, which is towards the upper end of the company’s target range. This would represent a sustained improvement in SSSg and underpin EPS growth of approximately 15% per annum over the next two years, in our view.

Cost growth has been an issue for franchisee profitability too. The cost of goods sold and wages represent 30% and 35% respectively of total expenses and have been under persistent pressure.

Financial stability and market performance

DMP’s balance sheet continues to inch towards the 2x net debt to EBITDA leverage target. The dividend reinvestment program was used in the 1H24 results; we expect it will also be used in the FY24 results in August. We do not foresee DMP breaching debt covenants over FY24-25. Evidence of improved sales performance will remove the balance sheet from the investment debate.

DMP’s share price has fallen 38% so far this year, while its Australian listed peers Collins Food (CKF) is down 23% and Restaurant Brands (RBD) is down 13%. In the context of a weak consumer spending environment, this is unsurprising.

DMP’s FY25 PE ratio is now around 23x. We think a fair PE ratio is 25x. This may suggest a limited upside from the current share price, but we expect consensus adjustments to store growth and margin recovery before becoming more positive.

Figure 1: DMP same store sales growth - consensus

Figure 2: Fair value for DMP is 25x PE ratio

Figure 3: DMP pricing strategy is working

Figure 4: ...and customers are responding

• ^{The information provided by Sandstone Insights does not constitute investment advice and does not have regard to the specific needs of any person who may receive it. No warranty is given as to the accuracy or completeness of the information and any person acting on it does so entirely at their own risk.}