Turkey crisis hits DP Eurasia

The core investment case for DP Eurasia, which floated mid-way through last year, is not hard to appreciate. It owns the master franchise to operate Domino's Pizza concessions in its territories. This means building and operating central commissaries that make pizza dough, which is then shipped out to stores along with other ingredients. Marketing and IT departments are also centralised. About two-thirds of DP Eurasia’s stores are franchised, providing a capital-light means of expansion, and the remaining third are corporate owned. Management has in the past said there's the potential for 2,400 Domino’s stores across the company's main markets. The aim is to have around 70 per cent of orders placed online, compared with 59.3 per cent at present.

Importantly, the markets DP Eurasia is targeting have plenty of potential. Populations are young, incomes per head are broadly on a positive trajectory, and there is increasing urbanisation; an important factor given the link between the profitability of Domino's stores and local population density. Indeed, the fact the shares trade at 16 times 2019 EPS forecasts even after the price has fallen nearly two-thirds from its late 2017 peak illustrates investors' high hopes.

While first-half trading to the end of June was strong, this covered a period before the recent crisis in Turkey really broke out, which, depending on what politician you listen to, has been exacerbated or caused by the imposition of harsh US sanctions. Indeed, since the end of DP Eurasia's first half, TRY has lost over a quarter of its value against the US dollar and about a fifth of its value against sterling. We see potential for noteworthy declines in the TRY-denominated forecasts in our table to add to the devaluation pain for UK-based investors. The outlook statement in interim results scheduled for 11 September is unlikely to be good.

While Turkey's fragile finances have meant TRY has been depreciating against the US dollar since 2008, the recent sharp currency fall is a reflection of a step up in concern about the country's perceived economic weakness and – from DP Eurasia's perspective -– the increased likelihood that consumer spending will come under pressure. At the same time, DP Eurasia's dollar-linked costs look set to rise sharply, with the company stating in its IPO document that no hedging was in place for commodity costs. Meanwhile, the impact on business confidence – especially that of potential franchisees – caused by weakening economic conditions and the ratcheting up of international sanctions on both Turkey and Russia could well have a knock-on effect for openings, which are targeted at 30 in 2018 for Turkey and 40-60 in Russia.

Indebtedness can also be expected to look worse as a result of TRY's slump. This is ironic because the company has recently sought to mitigate currency risk by converting TRY158m (£22m) of euro-denominated debt into a rouble-denominated loan paying a lofty 9.7 per cent interest rate. But TRY has not fared much better against the rouble than it has against the euro, depreciating by about a fifth against both. One potential bright spot regarding TRY's fall is that it could mean money earmarked for capital expenditure goes further.