Morgan Stanley Slice Domino’s Recommendation: Overweight to Equal-Weight

Morgan Stanley Slice Domino’s Recommendation: Overweight to Equal-Weight

Morgan Stanley Slice Domino’s Recommendation

Overweight to Equal-weight

On Tuesday 28 May, Thomas Kierath – analyst from Morgan Stanley – cut the target share price for Domino’s Pizza Enterprises Limited (ASX: DMP) from AU$50 to AU$41. Concurrently, Morgan Stanley slashed Domino’s rating to equal weight from overweight as it forecasted that Domino’s Pizza will deliver lower-than-expected profit and open fewer new stores in the next three years.

After the downgrade from Morgan Stanley, Domino’s share price was down over 7% to AU$37.72, being its lowest trading price since September 2015. In 2016, the share price even hit highs of AU$80. It is interesting that before Kierath sliced his recommendation of Domino’s Pizza, he had been one of Domino’s most bullish analysts and set a price target of $95 in 2016. But Domino’s Pizza couldn’t continue its strong double-digit growth in the past 10 years because due to its business slowdown in Australia and New Zealand which will be noted in the latter.

Domino’s Pizza Enterprises Limited is the largest pizza chain in Australia in terms of network store numbers and network sales. The first Domino’s store was opened in Queensland in 1983. When it was listed in the ASX in May 2005, it was the first publicly listed pizza company in Australia. With more than 2,400 stores, the company has a global brand network in Australia, New Zealand, Belgium, France, The Netherlands, Japan, Germany, Luxembourg, and Denmark. In 2016, Domino’s New Zealand delivered the world’s first ever pizza by drone. Now, Domino’s Australia owned 700 stores and just launched voice ordering through the Google Assistant.

The slow growth of Domino’s Pizza

Last Wednesday 22 May, Domino’s Australia and New Zealand Chief Executive Nick Knight alluded to some franchisees lacking the “passion or capabilities” to perform well. The group has bought back a record number of franchised stores in Australia and New Zealand with some of these being resold to better-performing franchisees while others were operated as corporate stores after launching a benchmarking program “Operations 360”. This was intended to provide a benchmark for franchisees to measure their performance. Mr. Knight was confident about this process that it would improve the average performance. However, the Domino’s group Chief Executive Don Meij, didn’t revise the profit guidance and told the analysts could “assume” to use the existing guidance.

Morgan Stanley forecasted that Domino’s couldn’t meet the minimum EBIT guidance. Prior to this, analysts indicated that Domino’s needs to achieve a 9% increase in earnings before interest and tax in order to meet its guidance for EBIT of between $227 million and $247 million in the year ending 30 June. Morgan Stanley found Domino’s addition of only a few stores in the past five months, while data showed a drop in Google searches for Domino’s Pizza. This indicated that both sales growth are respectively declining. Due to this, same-store sales growth in Australia and New Zealand was forecasted to around  2.5%. The figure is lower than previous guidance. Meanwhile, it was expected that in Australia and New Zealand, Domino’s could open only 24 stores in 2019 and 20 in 2020, compared with 42 in 2018 and 63 in 2017. Based on the low growth in sales and new stores, the EBIT in Australia and New Zealand was expected to have a 5% annual growth during 2019 to 2013, which is much lower than 17% in the period corresponding to 2015 and 2018.

Mr. Kierath also suggested that although the lower sales and store growth in Australia, New Zealand, and Europe could be partially offset by the weakened Australian dollar and higher earnings in Japan, Domino’s was still hard to meet its earnings guidance. He determined that the profit for 2020 to 2021 would be expected to a 6% to 8% lower than the past bullish forecasts.

Increasing competition and lacking innovation

In its business life, Domino’s used to be a market leader with developing online ordering, smartphone apps, and route tracking. However, their features have become commonplace with the rising of delivery services such as UberEats and Deliveroo.

At the same time, the report from Morgan Stanley showed that Domino’s was also facing increased competition online as rivals have updated their technology and eventually caught up. This can also be explained by “the law of large numbers” theory that the performance tending to be close, no company could keep an absolute advantage. The analyst commented that Domino’s new products such as Pizza Checker “lack the punch” compared with its previous technology innovation. Without new revolutionary product and service, Domino’s couldn’t maintain its past boosting sales.

Consequently, Domino’s Pizza seems to miss its guidance for earnings growth this year. Some mid-cap fund managers are focusing on this company and waiting for its value arising.

By Steven Gao

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