Domino's keeps rising

For a number of years investors have feared Domino's penetration of the UK pizza market could be reaching saturation point, but the evidence from its fellow master-franchise owners in different territories suggests such worries are wide of the mark. According to house broker Numis, the company's 26,000 households per UK store compares with 16,000 for Domino's in the US and 19,000 in Australia. And despite significantly higher household penetration and order frequency in these counties, the franchise is expanding and generating double-digit like-for-like sales growth. That suggests there should be plenty more growth potential in the UK, which Domino's is planning to exploit by increasing openings to 65 this year.

Domino's franchise structure means expansion requires relatively low levels of investment, and sales growth through the franchise system tends to have a proportionally larger impact on profits. This has been behind an impressive history of broker forecast upgrades which shows little sign of abating (see chart below), despite what may be suggested by recent share price weakness.

Ongoing EPS upgrades should push the shares higher. A key driver of continued growth in the UK is the company's strong digital strategy. The mobile app it has developed allows customers to track their pizza through each stage from preparation to delivery, something that appeals to its key millennial demographic. At the full-year results, management said e-commerce system sales were ahead by more than 30 per cent on the prior year and that app-based sales represented the largest distribution channel, driving 48.6 per cent of online sales. A whopping 77.7 per cent of all sales now come through e-commerce channels.

There is also upside potential from the recent joint-venture acquisition of Joey's Pizza in Germany, once its impact is more widely understood. Joey's is the largest pizza delivery operator in the country, with 212 stores nationwide, which rises to 227 when combined with Domino's German outlets. After several lossmaking years trying to build a presence in Germany, the purchase provides Domino's with the scale to gain traction in a nation that is keen on its pizza but where Domino's was barely represented.

Domino's is highly cash-generative, with net cash rising from £11m to £40m last year. Given the relatively limited investment the group should need to make to grow its UK network from 869 stores to an expected 1,200, management is looking to return cash through share buybacks. This should support the share price, although some may question the amount of value created by buying back shares trading at 23 times consensus next-12-months EPS.

That said, we don't think this looks a bad price for investors to pay for shares in a company generating consistent earnings growth accompanied by upward earnings revisions and eye-watering returns on capital employed (ROCE was nearly 70 per cent last year). Indeed, the current earnings multiple is well within the bottom two-fifths of the range over the past two years and offers 37 per cent upside to the highest forward multiple the shares traded at over the period.