How the Domino’s (ratings) fell!

Domino’s Pizza (ASX: DMP) might not be a staple of many people’s daily diet, but it is a staple of many superannuation funds, whether that be through direct ownership, or given it is likely held by default in most index tracking balanced funds. So, today’s massive price drop, nudging around 30% at the time of writing, is likely very concerning for many Aussie investors.

What could have gone so wrong that the market got it so wrong? Markets are supposed to be abreast of all of the fundamentals for every company, pricing their shares accordingly in real-time. In theory, this type of tectonic shift in a company’s valuation shouldn’t occur. Let’s investigate!

The downgrade

Domino’s reported after the market closed yesterday, just after 7pm. Let me just say that, in over 30 years of watching Aussie stocks issuing updates, reports this late after the market closes (unless the company is dual listed in either the UK or the USA), is usually a red flag in itself.

I’m not saying there’s anything funny going on here, or that companies are necessarily trying to sneak a not-so-great update through – going public is going public, at any time. But Domino’s timing, and the negative nature of the announcement, was a point of amusement among the Market Index team during our morning meeting!

The Deets (all changes versus are compared to H1 FY23):

• Same Store Sales +1.3% (Asia -8.9%, Australia & NZ +8.2%, Europe +0.6%)

• Network Sales +8.8% (Asia -1.0%, Australia & NZ +11.1%, Europe +3.8%)

• Net debt has reduced by $68.7 million to $770 million

• H1 preliminary net profit before tax (NPBT) is expected to be between $87 million and $90 million versus $104.8 million

• Any previous guidance for FY24 is no longer in effect

There are three obvious points of contention here: 

1. The poor performance of the Asian business, which Domino’s blamed mainly on a disappointing performance in Japan, 

2. The discrepancy between the NPBT figure compared to the prior corresponding period of H1FY23, and 

3. The pulling of FY24 guidance.

Pulling guidance is never a good look. Brokers overlooked it during COVID, but company management teams really should have a handle on how their businesses are performing by now. The fact Domino’s can’t provide at least a broad roadmap on where their business is heading in terms of profitability, is likely to be a concern to many investors.

On the H1 net profit downgrade, this indicates first-half profits are likely to fall around 15.5% at the mid-point, but by as much as 17% at the lower bound of the range. That’s a very decent whack by your garden-variety downgrade standards!

The reaction

Obviously, the effect on Domino’s stock price has been severe, and on the face of it, potentially even disproportionate so far compared to the percentage size of the downgrade. There’s an old saying, the market is always right, but to potentially provide a little colour on the market’s thinking, here’s how the major brokers responded:

Goldman Sachs

• Same-store sales growth of 1.3% is below brokers' estimate of 3.9%

• NPBT of $87 million - $90 million is 9% below brokers estimate and 14% below consensus estimates

• Japan singled out as a major sticking point for the business going forward, as the issues Domino’s faces there are more likely to be a “structural headwind” than temporary impacts of the pandemic

• Network sales cut by 4% to 6% in FY24-FY26 and EBIT by 8% to 14%

• Expects market to take news “negatively”

• Retains “Sell” rating, cuts price target by 6.7% to $37.50 (from $40.30).

Morgan Stanley

• Same-store sales growth of 1.3% is 3.3% below consensus

• NPBT of $87 million - $90 million is 12% to 15% below consensus

• Japan showed “green shoots”, but same-store sales growth deterioration of -8.9% was worse than the broker’s estimate of -4.5% and consensus -4.9%. Sees recovery to a flat result in January as a “positive”

• “Strong sales growth” in Australia & NZ due to new products, improved customer reach, +8.2% result was ahead of broker’s estimate of +7.5% and consensus of 6.5%.

• In Europe, a recovery in Germany was offset by weakness in France, same-store sales growth of +0.6% was below brokers estimate of +4.0% and consensus +4.4%

• FY24 earnings estimates are cut by approximately 12%, while FY25 and FY26 estimates are cut by a more modest approximate 2%

• Update is a “clear disappointment”, but this half is likely to be an “inflection point” for same-store sales growth and margins. The broker still expects the second half to deliver year-over-year earnings growth, and EBIT margins will return to pre-COVID levels by FY26

• Retains “Overweight” rating, cuts price target 2.8% to $68 (from $70).

UBS

• NPBT of $87 million - $90 million is 5.4% below the broker’s estimates and 13.8% below consensus

• Earnings per share estimates for FY24 are cut by 10.2%, and for FY25 cut by 9.9% due to “lower same-store sales growth” and margins”

• Australia & NZ same-store sales growth was “strong” but Asia was “weak”, Europe “slowing”

• Domino’s previously stated 7-9% organic store growth is now increasingly at risk as current same-store growth sales are concentrated in markets with the least room for store growth

• Broker notes this is yet another earnings announcement “below expectations”

• Broker is concerned that Australia & NZ growth won’t be translated into other markets that have greater store growth opportunities

• German performance is “pleasing”

• Domino’s trades on “elevated valuation multiples”, indicating potentially as much as a 40% premium at current 1-year forward P/E Ratio

• Retains “Sell” rating, cuts price target by 2.3% to $42 (from $43).

Morgans

• Downgrades rating to “Hold” from “Add”, price target cut 18% to $50 (from $61).

Jarden

• Downgrades rating to “Neutral” from “Overweight”, price target cut 23% to $50 (from $65).

Jefferies

• Downgrades rating to “Underperform” from “Hold”, price target cut 2.1% to $46 (from $47).

How the dominoes fell

Considering the above broker reactions, the average rating is now between Hold/Neutral and Underperform/Sell, and the average price target is $48.92 – a 10% reduction from the brokers’ previous average target.

Whilst this all sounds terrible for loyal Domino’s shareholders, I note that at the time of writing, Domino’s is trading around $39.60, and this is a hefty 23.5% below the average of the brokers’ price targets (which range from $37.50 to $68).

Clearly, Domino’s is a polarising company among the brokers, and the dynamic nature of its business since the onset of the pandemic is causing plenty of headaches for investors and analysts alike!