Domino’s has delivered a post-market trading update highlighting very weak sales in Asia and slowing sales in Europe for 1H24e. The tone of the update also suggests progress, but not enough, on franchisee profitability. We expect it will take longer for store rollout to improve and as a result remain negative on valuation grounds.
Domino’s trading update revealed that sales trends have softened in Europe and remain negative in Japan. Sales are solid in Australia/NZ. The company emphasised earnings are recovering, but the qualifier is that 1H24e EBIT is likely to be down year-on-year. Domino’s is focused on improving franchisee profitability.
Harvey Norman reported a large drop in 2H23 earnings with EBITDA down 29%. The fall reflected lower sales and significant operating leverage. An increase in its licence fees for offshore masked a larger fall in Franchise segment margins. Given declining sales likely in 1H24e, we expect EBITDA to drop further. With a declining sales and earnings backdrop, combined with devaluations of its property book, we remain cautious.
Domino’s FY23 EBIT of $202 million is likely a trough given the company’s cost saving program. While pleasing, the lingering concern we have is focused on is weak franchisee profitability, which will limit new store openings. Moreover, Domino’s balance sheet may avoid any major capital raising, but it is also constraining support for franchisees when compared with offshore peers.
Harvey Norman’s share price is trading below book value of $3.55 per share. In this report, we analyse its property value and Franchise margins. The company has over $3.7 billion in property and an enterprise value of $4.7 billion. The last reported cap rate on its investment property was 5.4% in FY22. By FY24e, we see the cap rate rising to 7.5%. We expect its property value to drop by more than $800 million and Franchise margins to fall below 2019 levels.
Harvey Norman reported a 2% increase in system sales but a 7% drop in group EBITDA for 1H23. The result showed margin pressure from increased discounting across its businesses. The deterioration in its recent sales trends suggests it will be a tougher 2H23e and FY24e in our view. An added risk for Harvey Norman is the higher than usual franchisee inventory holdings, which could squeeze margins further over the next 12 months. We expect margins to largely normalise to pre COVID-19 levels as sales slow and discounting levels increase.
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.
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