Shares in Domino’s Pizza (DOM) have fallen by nearly 10% to 286.5p over the past week as two analyst research notes have expressed concerns about rising competition, increased price discounting, new stores cannibalising existing sites and a weak consumer backdrop.

These factors could put pressure on franchisees’ like-for-like sales, says investment bank Investec which believes the shares could fall further to 271p. It says rising food and labour costs could squeeze profit margins which in turn could reduce the number of new store openings.

What are the other concerns?

Investment bank Berenberg believes Domino’s no longer has superior technology as rivals have played catch up. Competitors such as Deliveroo and UberEATS use GPS tracking so customers (and restaurants) can see the exact location of the delivery driver.

Even more worrying is the fact that two franchisees accounted for 42% of Domino’s UK and Ireland revenue in 2016, according to Berenberg, owning circa 400 stores. It says cost pressures may affect franchisees’ ability and willingness to put money into local marketing and bundled food deals.

‘If franchisees are unable or unwilling to put the same level of resources into these areas then it would likely have a materially negative impact on sales,’ says Berenberg.

We flagged competition and store cannibalisation issues with Domino’s in the 20 October 2016 issue of Shares. The majority of its new store openings last year were created by opening sites in existing trading areas rather than expanding into new geographic territories. You will see this referred to as ‘splitting’ in its financial results.

‘Domino’s recently quantified the impact of store splits on like-for-like sales, with store splits cannibalising the existing estate and reducing like-for-likes sales by 2.4% in the 2016 financial year,’ says Investec.

Gross margin fears

Aggressive discounting by rival operator Pizza Hut has prompted Domino’s to introduce two new cheaper bundle deals, according to Investec.

It is selling any two pizzas for £20, which is a 50% discount compared to the price if you bought two large pepperoni pizzas individually from one of its London stores. The same 50% discount is found with the other bundle, being a £24 pizza, sides and drink deal.

Discounted bundle deals represent 80% of Domino’s sales, so the latest price cuts will have a meaningful (negative) impact on gross margins – particularly if customers get used to the lower pricing structure and order less often when Domino’s eventually tries to push prices back up.

We agree with the analysts’ concerns and believe
the shares could remain weak for some time. Avoid
for now. (DC)

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