The full potential of Domino’s (ASX: DMP) businesses in Japan and France, both large markets in its portfolio of 12 countries, is unlikely to be unlocked in the near term.

Management expects it unlikely that the store count in those jurisdictions will grow in fiscal 2025 as franchisee profitability must recover first before store growth can resume. While the firm maintained its long-term target of nearly doubling its global store footprint, timing is subject to a recovery in sales growth. We trim our outlook for near-term profit margins and new stores, with our fiscal 2025 earnings per share estimate declining by 11% to $1.88.

We believe these challenges and weaker trading conditions in some other markets are weighing on investor sentiment. Nevertheless, we believe narrow-moat Domino’s growth potential is unaffected, and our long-term earnings outlook is virtually unchanged.

At current prices, shares trade at a material discount to our unchanged $61 per share fair value estimate. We forecast an earnings compound annual growth rate of 21% for the next five years, underpinned by its global store rollout. We forecast the network to grow to 6,200 stores by fiscal 2033, below management’s long-term target of 7,100. Hitting management's target by 2033 would lift our valuation by about 11%.

Japan is the country of interest. Domino’s rapidly expanded its Japanese store network during covid-19, when sales boomed. The network grew to over 1,000 stores from 600 stores in June 2019.

However, the expansion is coming with severe growing pains, with many of the network stores immature and still establishing themselves in their respective markets. Increasing average weekly order counts is the key driver in improving the performance of those stores.

Domino’s intends to accelerate store maturity and franchisee profitability by increasing marketing spending. We expect store growth to recover in Japan, but greater marketing costs will weigh on near-term profit margins.

Business strategy

Domino's Pizza Enterprises is the Australian master licence holder of the Domino's Pizza brand. It also has operations in New Zealand, Japan, Singapore, Malaysia, France, Germany, Belgium, Luxembourg, Taiwan, Cambodia, and the Netherlands.

The stock suits investors seeking exposure to the food and beverage sector. Management is active, importing marketing strategies from the United States, or creating new ones, and applying them to local trends in individual markets. Management has adapted to market trends by refreshing the product range, including healthier ingredients and gourmet styles, and transitioning to online ordering.

As a master franchisee, Domino's has limited capital requirements, which means royalty payments it receives in the future should continue to be paid as partially franked dividends. This makes returns on invested capital very attractive.

Brand and scale are key competitive advantages warranting a narrow economic moat rating, and future growth prospects are significant. Despite significant growth during recent years, Domino's is by no means a mature business. Australia can still increase its store base by about one third in the next few years, and European growth is much more substantial, with potential to more than double the existing store base to around 2,900 outlets during the next decade.

Risks include a change in consumer taste for pizza as a food category and growth execution risk, particularly with differences between Australian, Asian, and European business environments. Good management can navigate these changes. McDonald's modified its menu in response to an increasingly health-conscious society; we see this as a perfect example of a food business changing with the times.

Moat rating

Learn more about finding a company with a moat.

We believe Domino’s warrants a narrow economic moat, sourced from intangible assets and cost advantages. Intangibles are derived from very strong global brand recognition.

Domino’s was formed in 1960 and now extends to over 80 countries, with over 16,000 stores. Intangibles also stem from internally generated intellectual property, with the firm a leader in restaurant logistics and technology tools that build and maintain customer engagement and loyalty.

The majority of its global sales are sourced from digital channels. In Australia, over half of those digital sales come from its mobile app. Domino’s investment in streamlining its cooking and fulfilment process makes it the "go-to" location for individuals who covet the fastest and most reliable service.

We see durable cost advantages in advertising, as Domino’s gains far greater leverage from above-the-line advertising than smaller peers. Being one of the largest operators in each market means the firm can advertise at a lower average cost per outlet than smaller peers. This helps elevate and keep the brand top of mind for consumers—for example, Domino’s Australia has over 1 million likes on Facebook.

High brand awareness, longer trading hours, and sophisticated home delivery capabilities means Domino's stores have high sales productivity. This enables the firm and franchises to rent stores in better locations than less productive smaller pizza restaurants. We anticipate this as conducive to market share growth over the longer term.

Operating one of the largest global pizza franchises allows Domino’s to pool resources and outspend competitors on innovation. Technology innovation improves convenience, which next to value is the key sales driver. The technological platform is shared globally and spans: a digital loyalty program enabling electronic redemption of "reward pizzas"; electronic customer profiling; geotracking of pizza being delivered to homes; and customer geotracking to have pizza ready just as they enter the store.

Other benefits in recent years of Domino’s innovation team include high-speed ovens and a re-engineered fulfilment process that appear best-in-class. Detailed monitoring of every aspect of the ordering, cooking, fulfilment, and deliver processes means bottlenecks and downtimes are minimized, enabling Domino’s to offer faster delivery times than competitors. Delivery times in Australia average 20 minutes, with the largest competitor, Pizza Hut, reportedly sitting at around 30 minutes.

The firm's large network gives it some cost advantages in the procurement of consumables. It also increases the proximity to markets and therefore improves customer convenience.