The share price of Domino’s Pizza Group (LSE:DOM), the UK-based master franchisee for Domino’s Pizza International, closed up 8% on 9th March after reporting earnings for FY2020. System sales (total sales for both franchised and corporate stores in the UK and Ireland) grew 10.3% to £1.35 billion for the year on a like-for-like basis, and underlying net profits grew slightly from £81.1 million to £84.3 million.
Part of the reason for the jump in the Domino’s Pizza share price was due to the announcement of a new growth strategy aimed at increasing system sales to £1.6 billion to £1.9 billion in the medium term. To achieve this, the company plans to open 200 new stores and grow the collection side of the business. If the company executes this new growth strategy successfully, it could grow revenues annually at anywhere between roughly 6% and 12% over the coming few years.
Management also revealed a new capital allocation philosophy focusing on returning cash to shareholders. As part of this, the company announced a dividend of 9.1p for FY2020 and a £45 million share buyback programme.
Currently, the Domino’s Pizza share price looks quite attractive at 337p, representing a price-to-underlying-earnings (P/E) ratio of 18.5. This seems low to me, given the growth the company could see in the coming few years thanks to the new strategy.
What are the risks?
The story isn’t quite so simple, however. One hitch in the investment case above is that I think Domino’s Pizza will find it difficult to maintain its current rate of growth. During the Covid-19 pandemic, the company benefitted hugely from the forced closure of restaurants, as this caused demand to shift towards delivered food. This was certainly a significant contributing factor to the jump in the growth rate of system sales from 3.7% in FY2019 to 10.3% in FY2020. As lockdown measures ease and restaurants reopen, some demand is likely to shift back to restaurants, making a repeat of this year’s growth in the coming few years unlikely.
Having said this, revenue growth in the 6-8% range is entirely possible, especially when one considers that the company achieved an annual growth rate of 6.4% in the three years leading up to the Covid-19 pandemic. Even with growth in this range, Domino’s Pizza shares still look attractive to me.
Another issue with the investment case is the problems the firm is having in its international markets. While the core (UK and Ireland) business is doing well, the company’s ventures in other markets such as Norway, Sweden and Iceland have performed poorly. In FY2020, these international businesses reported a £10.1 million loss and incurred an impairment charge of £22.6 million, representing a significant drag on the business and one not reflected in underlying earnings.
However, Domino’s Pizza is in the process of exiting these international markets. In May 2020, the company successfully sold its Norwegian business and has recently reached an agreement to sell itsSwedish business. As this divestment process is completed in the coming years, the burden of these businesses will be lifted, allowing the core business to potentially grow unhindered.
Overall, I think the long-term outlook looks positive for the company. Trading at an attractive valuation, I rate Domino’s Pizza shares a buy for my portfolio.