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Should you buy Domino’s (ASX:DMP) shares after its recent broker upgrade?

After a disappointing November, the Domino’s Pizza Enterprises Ltd (ASX: DMP) share price surged over 12% yesterday following a virtual investor presentation and several broker upgrades with higher price targets.

In particular, Goldman Sachs upgraded its 12-month target price from $83.90 to $88 per share, with the current DMP share price at around $83 at the time of writing. Are Domino’s shares a buy today?

DMP share price chart

Source: Rask Media 6-month DMP share price chart

Well, I personally wouldn’t buy straight after an announcement that’s caused the share price to jump this quickly, however, I do think there’s a pretty strong investment case for a further long-term hold here.

I think it’s important to understand why this company has performed so well over the last 10 years, and how likely it is that it’ll be able to continue on this growth trajectory in the coming years.

Overseas integration

Domino’s operates stores across nine different countries that all do the exact same simple thing: make pizza. However, while all countries typically share the basic operational framework, differentiation comes from understanding cultural differences and adapting the business model accordingly to suit different consumer preferences.

As an example, Japanese consumers rarely ate pizza or any fast food when Domino’s first entered this market, but now this segment contributes around 20% of the company’s total annual EBITDA.

Data

This growth has been driven by the collection of lots of customer data, which helps drive further insights into consumer behaviour. In the past, pizza has typically been seen as a meal for special occasions, but the current strategy has evolved it to be for any occasion, be it by yourself or in a family setting.

The data has also revealed that customers really don’t like waiting long delivery times for their orders. How many times have you enjoyed your meal but the overall experience was brought down from the delivery process?

Domino’s has had a GPS driver tracker for a while now, which lets the buyer know in real-time how far away their order is. It has additionally focused on increasing efficiencies which shave minutes off delivery times.

I find this fascinating from a marketing perspective because the GPS feature doesn’t actually mean the order will be delivered any faster. However, having a real-time location seems to really improve the customer experience, which has led to decreased customer churn rates and more loyalty among customers.

Domino’s valuation

The qualitative aspect of Domino’s is quite compelling, but I think it’s still always wise to get a rough sense of valuation when it comes to the company’s shares.

Domino’s shares currently trade on forward P/E ratio of 41.1 based on consensus estimates for FY21 earnings, which are indicating earnings growth of 25% next year.

While this may seem stretched, I’m also not the sort of person to throw out an investment idea simply because shares look expensive on a P/E basis – the high price tag often represents a high-quality business with a promising future.

In this case, I believe the share price is a reflection of the fact that Domino’s plans to pretty much double its current store count between 2025 and 2033, with an outlined target of around 5,550 stores in this time.

Overseas expansion will continue to be the focus, with the total amount of planned stores as follows:

  • Europe – 2,850 stores (currently 1140)
  • ANZ – 1,200 stores (currently 839)
  • Japan – 1,500 stores (currently 681)

One thing to keep in mind is that continuing to break into new markets to supercharge growth is highly capital intensive and in the case of Domino’s, this has resulted in fairly high levels of debt on the balance sheet. At the end of FY20, the company had $658.1 million in long-term debt, a number which has progressively increased over every year of operation.

While this level of debt could be a cause for concern, it’s also worth noting that in FY20, the company announced it had delivered an underlying return on equity (ROE) of 40.8%, with a three-year average return of 41%.

All things considered, I would say that the Domino’s share price is around fair value at its current level, although given the recent rotation out of some of these COVID-19 beneficiary shares, it might be worth at least waiting to see if it pulls back slightly further from here.

Summary

It truly is amazing that a business that sells pizza for as little as $5 has managed to grow into a $7.2 billion company.

It seems to be extremely well managed and has a strong track history of delivering shareholder value, and I’d be willing to back management as the company plans to continue to expand in overseas markets.

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At the time of publishing, the author of this article does not have a financial or commercial interest in any of the companies mentioned.

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