Domino’s is Britain’s largest pizza delivery company, with about a 43% share of the £815m market in terms of system sales. The group is neither a fast-food restaurant (there are no eat-in facilities), nor a takeaway (on average only 30% of food is collected), and has 553 stores nationwide, each run by a franchisee.
Domino’s Pizza (LSE:DOM), rated a BUY by Seymour Pierce
Typically, each franchisee is granted an area for ten years, invests roughly £0.2m upfront, pays Domino’s ongoing royalties, and can expect to break-even after two years. The group owns the rights to run the franchise in Britain and Ireland and in turn pays a 2.7% fee to the ultimate owner, US-based Domino’s Pizza Inc.
The directors should be applauded for the company’s past results. Both sales and earnings per share have risen consistently from £45m and 4.0p in 2001 to £136m and 10.7p in 2008, with 16% of deliveries now ordered online. This growth is set to continue, with forecast 2009 sales and earnings per share of £147m and 11.9p respectively, rising to £162m and 13.2p in 2010. This has been driven by the recruitment of new store owners, increased like-for-like sales and a recent shift in eating habits away from expensive restaurants.
Domino’s is certainly a quality firm. But I can see some potential problems ahead. With credit availability getting tighter, it will get harder for franchisees to fund new outlets. Despite an “exceptional start to 2009” due to January’s heavy snow, I reckon sales will soften later in the year. Takeaway pizzas are more expensive than similar products from supermarkets. As the dole queues lengthen, fewer families will pay this extra cost, or will reduce the frequency of their consumption. This is already happening in America, which was first to enter the downturn. Last Tuesday, the mother firm, Domino’s Pizza Inc., reported a 32% fall in fourth-quarter 2009 net income and predicted flat like-for-like sales at its domestic stores. It added that although costs were falling, this would not be enough to offset consumers cooking more often at home.
Worse still, it seems that loan default rates on Domino’s US franchisees are piling up too. So even if the UK group meets its tough target of 13% earnings per share growth in 2009, then – trading on toppy p/e ratios of 17.7 and 16.0 for the next two years – the shares are overcooked.
Recommendation: SELL at 211p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.