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'Hold the anchovies!' Domino's Pizza seen as $800m overvalued in profit squeeze

Patrick Hatch
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Domino's Pizza is more than $800 million overvalued and will not meet its ambitious growth targets because it needs to share more profit with its store owners, investment bank Citi says. 

In an explosive research note, titled Hold the Anchovies, Citi analysts said there was not enough incentive for store owners to open new Domino's outlets under the current profit split arrangement.

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'If you're not a favourite, you're going to lose'

Consumer advocate Michael Fraser on the Domino's pizza franchisees.

"Domino's has enjoyed very strong profit growth, but the health of the franchisee is crucial to further success," the analysts, led by Craig Woolford, said. 

"Domino's has taken its share of the profit pool as far it can realistically go. Franchisees will need to see an equal share in earnings growth from here." 

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While the income at head office had grown at 9.5 per cent annually over the past 12 years, income at franchisee-owned stores had edged up only 1.2 per cent a year - less than inflation, Citi said. 

Head office profit growth was likely to slow to 4.4 per cent a year over the next nine years as the company would need to share its spoils more evenly with franchisees, the broker said. The chain's operating profit margins would, meanwhile, peak at 39 per cent - short of Domino's long-term target of 45 per cent. 

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Citi said franchisees were earning a post-tax return on capital of about 12 per cent, which needed to grow to about 15 to 20 per cent to make opening more stores worth their while. But overall sales growth was likely to slow by about 2 per cent as new Domino's stores cannibalised existing ones.

A Fairfax Media investigation earlier this year revealed that the uneven profit split between Domino's head office and store owners was pushing franchisees to underpay staff in order to stay above water. 

Citi said franchisees' complaints went "to the heart of Domino's business model and earnings outlook", and indicated Domino's share of the profit stream was nearing a peak. 

Starting coverage of the stock with a "sell" rating, Citi gave Domino's a target price of $45.50. Dominos shares closed at $52.60 on Thursday, down 3.63 per cent on the previous day. 

Citi's outlook comes after Deutsche Bank advised its clients to sell the stock, and JP Morgan moved the stock to hold. 

Domino's shares fell 3.5 per cent lower at $52.65 on Thursday. The stock has fallen 19 per cent so far this year. 

While struggling in its home market, Domino's operations in Europe still had scope for store growth, but would fall short of the company's target of having 2600 outlets by the year 2025, Citi said.

It suggested 2400 stores were more likely, while the chain would have 750 stores in Japan by 2025, 100 short of its target.  

A Domino's spokesman said it did not comment on the company's share price, and that it and its franchisees' focus "continues to be on providing a high-quality experience to our customers, which we are doing in record numbers". 

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