Share price valuation: Domino’s Pizza Australia — as of 01/12/2018
Domino’s Pizza Enterprises Limited (DMP:ASX) is a publicly listed company on the Australian Securities Exchange that comprises over 2,400 retail food outlets across Australia, New Zealand, France, Germany, Netherlands, Belgium, and Japan. This report provides a financial valuation of DMP through the means a detailed qualitative analysis review and use of multiple quantitative valuation methods using key indicators of future cash flows, growth and risk.
Based on the most robust model of the DCF and taking a conservative approach to forecasting future value, DMP was valued at $53.72 per share, on 01.12.2018
As an addition, sensitivity analysis and a Monte Carlo simulation were conducted to test the sensitivity of the share price to small changes in Terminal Value through adjusting growth rate, Beta, and cost of capital, to test for the volatility of this share price valuation.
Industry Analysis
DMP is in the Fast Food and Takeaway Food Services industry, also known as Quick Service Restaurants (QSR). Globally, this industry is expected to grow at a CAGR of slightly above 4.20% between 2017 and 2022, expected to reach above USD 690.80 billion in 2022 (Zion Market Research, 2017).
DMP is positioned in three major geographical regions within this industry: ANZ, Europe and Japan. In Australia, the industry had an annual growth of 3.7% from 2013–2018 and a forecasted growth of 0.7% from 2018–2023 (Ibis, 2018), while in New Zealand the market is competitive and still has room for growth (Roy Morgan, 2018).
In Europe, some analysts estimate that the market is far from reaching its potential, expected to grow $10.3b from 2018–2020 with a potential for much higher penetration of up to $108b (Aaron Allen & Associates, 2018).
The QSR industry in Japan is highly competitive and streamlined, with the number of restaurants decreasing yet sales increased by 6.5% to 31.78 trillion from 1991–2014 (USDA, 2017). It is expected to reach 44 billion U.S. dollars by 2020 (Statista, 2018).
As of 2018, the distribution of revenue across the regions is as follows: 34.7% in Europe, 34.6% in Japan, 29.1% in ANZ and 1.7% categorised as ‘unallocated’. The total revenue for DMP in 2018 was $1,173,481,000 including sales and other revenue (IBIS, 2018).
SWOT
PESTEL
Company Snapshot
In recent years, DMP has seen rapid growth, with their number of stores increasing from 1,580 to 2,193 between 2016–2018 and already 70 new stores added in the first half of 2018 (Fung, 2018).
DMP has evolved from a traditional fast-food company to be a technology-focused enterprise driving rapid growth through mergers/acquisitions and digital transformation. (M&A Source, CTO source). Their approach to increasing market share and revenue has been through:
• increasing same-store sales by process improvement including their 3-minute pizza preparation and 10-minute delivery
- increasing their number of stores, both organically and through mergers/acquisitions (Homewood, 2018; McDuling, 2018).
Competition
Due to its wide geographic position, DMP’s competitive set is diverse. In ASX listed companies, the Retail Food Group and Collins Food Group are their main competitors. At a global level, they compete with other large QSR corporations such as Yum! Brands, Subway and McDonald’s. However, they also have to compete with locally preferred independent companies in each region, particularly in Europe and Japan where local ingredients and flavours still have a strong preference (USDA, 2018).
Management Team
DMP is led by Donald Meij as Group CEO, Executive Director and Managing Director. Starting as a delivery driver, Don is now Australia’s highest-paid CEO, earning 36.84 million in 2017. Although he has driven an important transformation process for DMP, he has been criticised on numerous occasions for overly optimistic forecasts (Aston, 2018).
Another executive role worth highlighting is Michael Gillespie, who has been since 2014 the group’s first Group Chief Digital & Technology Officer. This position has been key to increasing DMP’s competitive advantage as a technology leader.
Financial Ratio Analysis
DMP outperformed the industry average with respect to its Return on Equity (ROE) generating ROE of 33.61% which compares to the industry average of 15.20% over the past 12 months.
This suggests that DMP has generated significant profits from minimal equity capital. With a cost of equity of 8.55%, and DMP’s returns covering its costs by in excess of 23.58%, DMP utilises its capital effectively and efficiently and is most likely sustainable as they pay less for capital than what it generates in return (Yahoo Finance, 2018).
Relative Valuation Model (RVM)
The ASX 200 Consumer Discretionary Index encompasses companies which are the most sensitive to business cycles, including restaurants and consumer retailing. By comparing Dominos price-to-earnings ratio to this index, we have determined the valuation of Dominos to be $49.64 (using earnings per share of 1.84 as at 1 November 2018). This suggests the current market price is overvalued as the implicit market price-to-earnings ratio is 30.35 which is higher than the industry price-to-earnings ratio.
Discounted Cashflow Model (DCF)
The discounted cash flow model considers all the future cashflow that a firm generates to arrive at a valuation of its enterprise value. Since this value is shared between the equity and debt holders, the yearly free cash flow is discounted with WACC. The free cash flow is influenced by the firm’s profit, depreciation, capital expenditure and changes in net working capital.
Assumptions:
Sensitivity Analysis
Terminal value from the base case was used for the sensitivity analysis as it forms a larger proportion of the DCF value given the forecast was for 5 years.
At a minimal growth of 0.53% the lack of steepness in this curve shows that increases in the WACC has a smaller effect on the terminal value. In the base case Dominos, the WACC is 8.84% and placed on the flatter part of the light blue (2.53% growth) curve above, showing a lower sensitivity to small changes in WACC.
The sensitivity of the terminal value was also tested against the Beta of Dominos and the internal growth rate. Beta is used to calculate WACC and it influences the costs of equity incurred by the firm
When beta was varied between 0.5 to 1.5, the resultant terminal value showed high sensitivity below beta values of 1. When coupled with growth rates the effect on the terminal value is magnified exponentially for higher growth rates with lower beta values.
In the base case of Dominos, the Beta value is 0.94 and the sensitivity of the terminal value to small changes in beta was marginal. If the Beta was less than 0.9, then small changes (0.1) have magnified effects on the terminal value. In addition, if the growth rate also changes by a small amount (0.5%) this magnification is significantly intensified as shown by the steepness of the curves for Beta values below 1.
Monte Carlo Simulation:
A Monte Carlo Simulation (MCS) was conducted to simulate the impact on the free cash flows (FCF) by varying both g and WACC by a 1% over 1000 iterations. By analysing the DCF with a Monte Carlo Simulation a high probability (90%) range for the NPV can be estimated. Results are summarized in the preceding table. It shows an investor there is less than a 5% chance of the NPV or the Enterprise value is less than $5.04B or greater than $5.82B adding a high probability confidence interval range for the estimated intrinsic value and forecasted share price.
Summary
The RVM is highly dependent on the sector valuation, and PE ratios can differ within industries because of capital structure. The industry benchmark, in this case, is Australian, which may not consider Dominos international operations, and so we consider the valuation a poor estimate.
The DCF is the most robust of the valuation methodologies explored. BAsed on assumptions made and forecasted projections, the estimated value of Domino’s is $53.59. This result is consistent with analyst consensus where the average analyst valuation is at $51.17. (Factset, 2018)
THIS IS BY NO MEANS TO BE CONSIDERED AS INVESTMENT ADVICE. YOUR PERSONAL CIRCUMSTANCES HAVE NOT BEEN CONSIDERED IN THE ABOVE VALUATION AND YOU SHOULD CONSIDER PROFESSIONAL INVESTMENT ADVICE FROM A LICENSED INVESTMENT ADVISOR PRIOR TO MAKING ANY INVESTMENT DECISIONS.
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