We aren’t a willfully contrarian bunch at Shares, but now and then we come across a stock which seems so beaten-down with so much bad news priced in we just have to take a closer look.
A case in point is FTSE 250 fast-food firm Domino’s Pizza Group (DOM), the UK’s leading pizza brand with over 1,360 stores in the UK and Ireland.
Ironically, eight of the 10 brokers covering the company have a ‘buy’ or ‘strong buy’ rating on it, yet the shares have fallen to their lowest valuation on cyclically-adjusted earnings for over 20 years, which suggests there’s no love for the stock among investors.
NEW DEAL UNDERPINS TARGETS
Domino’s operates on a franchise basis, that is the company holds the rights to own, operate and franchise Domino’s stores in the UK and Ireland on behalf of brand owner Domino’s Pizza Inc (DPZ:NASDAQ).
If you run a successful business, franchising is a cost-effective way to expand as you don’t have to cover the cost of renting or buying a location, or of paying staff, so all incremental sales flow through into profit.
For the franchisee, they can run their own business using their local expertise while benefiting from the franchise owner’s brand recognition and customer loyalty as well as their purchasing power and ongoing business support.
Domino’s hasn’t always had the greatest relationship with its franchisees in the past, but in December 2024 the firm announced it had reached a new five-year framework with its franchise partners ‘to capitalise on its significant long-term opportunity’.
Specifically, the company said the new deal underpinned its confidence in its targets of 1,600 or more stores delivering £2 billion of system sales by 2028 and 2,000 stores delivering £2.5 billion of sales by 2033 ‘driving profit growth across the system’.
Under the new arrangement, the group’s marketing spend – which is largely funded by a small levy on franchisees’ sales – will be increased with a particular focus on digital ad campaigns and the Domino’s app, which is used by 9.5 million customers, while there are new incentives for franchisees taking on territories with a lower address count and a new food rebate mechanism to increase like-for-like orders during campaigns.
IMPROVED TRADING
At the half-year stage, the firm said it had seen a ‘notable improvement’ in orders from the middle of May 2024, with deliveries ‘stable’ after 10 consecutive quarters of decline and with momentum continuing through June and July, helped by the England football team’s good performance in the Euros, although it said the market was still ‘uncertain’.
While it anticipated some food cost deflation this year, it decided to pass on a greater level of savings to franchisees in the second half, to help drive volume growth and market share, meaning full-year EBITDA (earnings before interest, tax, depreciation and amortisation) would be at the lower end of the range of market expectations.
By the time of the third-quarter update, the firm said it was seeing accelerating growth in delivery orders and a return to positive like-for-like sales, which was continuing into the fourth quarter, meaning underlying sales were improving not just thanks to the Euros.
‘Total third-quarter orders were up 3.5%, with great strengthening in delivery orders of 6.6%, which I am really proud about,’ said chief executive Andrew Rennie on the conference call with analysts.
Collection orders were ‘down a bit’ due to customers switching to delivery, but ‘we are getting more order count growth, which is what we want,’ explained Rennie.
‘We are focused on growing our like-for-likes in a sustainable way, and I think the key word here is sustainable, driven by order count growth, not pricing, meaning lower ticket prices for customers and sustainable like-for-like sales growth driven by volume. So real growth, real core growth.’
Rennie said the aim for 2024 was ‘to bank customers, because we know with what is coming next year there will have to be a bit of price taken. However, we have actually been able to bank the customers before that happens, unlike a lot of others.’
Crucially, in the first five weeks of the fourth quarter – which included the run-up to the Budget and the immediate aftermath – sales were up nearly 6% on a like-for-like basis, and the company confirmed EBITDA would be in the revised range of expectations.
IMPROVING SHAREHOLDER RETURNS
At the half-year stage, the firm announced a 6% increase in the interim dividend to 3.5p per share and a £20 million buyback ‘reflecting confidence in future prospects’.
With a market capitalisation of £1 billion, a £20 million buyback represents an automatic increase in EPS (earnings per share) of a little more than 2% which isn’t too shabby.
Since March 2021, Domino’s has returned £461 million or around 46% of its current market cap to investors through dividends and buybacks, and thanks to its cash-generative, asset-light model – and with the added benefit of its new agreement with franchisees – there is no reason to believe it can’t continue to grow shareholder returns.
The key is overcoming negative investor sentiment – we weren’t surprised to see the shares slump on 9 January when Greggs (GRG) was punished for reporting weak like-for-like sales, even though Domino’s is bucking the trend.
These articles are provided by Shares magazine which is published by AJ Bell Media, a part of AJ Bell. Shares is not written by AJ Bell.
Shares is provided for your general information and use and is not a personal recommendation to invest. It is not intended to be relied upon by you in making or not making any investment decisions. The investments referred to in these articles will not be suitable for all investors. If in doubt please seek appropriate independent financial advice.
Investors acting on the information in these articles do so at their own risk and AJ Bell Media and its staff do not accept liability for losses suffered by investors as a result of their investment decisions.
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