Domino’s reported a 6% drop in EBIT despite 11% sales growth in 1H22. The company saw a decline in SSSg for Japan and some disruptions in Australia/NZ. Domino’s noted that Japan sales are rebasing lower, which will lead to lower sales growth through to September 2022 in our view. Our key observation from 1H22 result was cost growth running ahead of sales growth. Such growth was outsized and if it continues will dampen margins across FY22e.

We expect a more mild slowdown in Domino’s same store sales growth (SSSg) in key markets as higher COVID-19 cases are likely to lead to more sales of pizza. Our analysis of data from restaurant bookings in Japan has shown a drop recently, which is likely to lead to more home delivered food. Europe is also likely to have decent SSSg in 1H22e. In the report, we address  Domino’s Japan’s potential same store sales path; Domino’s Europe’s exposure to rising COVID-19 cases; and The upside and downside risks from here.

Domino’s AGM trading update has ignited the debate about the extent to which the company has been a beneficiary of COVID-19 lockdowns. Japan is likely seeing -25% same store sales in October. Sales declines in Japan are likely for another 12 months and Europe may have a very soft 2H22e as well.  Domino’s is a well-run business with good long-term growth, but its sales and earnings will reset as lockdowns ease.

Domino’s European investor day reiterated the desire to rollout stores and emphasised a focus on acquisitions where possible. The company has an impressive track record in lifting sales productivity, especially in Germany which is up 61% in four years. Despite competitive threats, Domino’s has become the dominant pizza offering in each EU market. While the long-term story is intact, we doubt there will be any changes following the investor day and the company still faces a headwind to sales over the next 18 months.

Domino’s faces a risk of slowing sales. We expect same store sales growth (SSSg) to slow meaningfully over the next 12 months. While Domino’s has had strong sales and store openings, some of its sales gains are a result of COVID-19 lockdowns in our view. In Japan we expect SSSg to turn negative in 2022, this is the region that had the largest growth over 2020 and 1H of calendar 2021. As economies reopen, consumers will have other food choices.

We initiate coverage of Domino’s Pizza Enterprises. The company is the master franchisee for Australia, New Zealand, Japan Taiwan, France, Germany, the Netherlands and Benelux. The company has recently upgraded its long-term growth targets, but also the long-term opex and capex outlook. The upside risks are faster store openings, better margins and additional territories such as Korea. The downside risks are COVID-19 unwind of sales, more capex and online competition from delivery aggregators.