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Although the resignation of both its chief executive (CEO) and chief financial officer (CFO) in the past five months looks bad for Domino’s Pizza (DOM) investors should not jump to conclusions. International expansion has yet to meet targets yet the core UK business is solid. The £758 million cap continues to be a strong earnings growth and cash generation story and this will not go unnoticed in private equity circles, especially after a spell of poor share price performance.

The shock resignation of Domino’s boss Lance Batchelor (6 Dec) leaves investors worried about possible internal troubles within the fast food giant, given the news closely follows July’s announcement from CFO Lee Ginsberg he is leaving next March after ten years in the post.

Batchelor is understood to be taking up the CEO position of insurer-to-travel group Saga in May 2014. He became the driving force behind Domino’s overseas expansion three months after his appointment as deputy CEO in January 2011. This plan has not gone well. As such, we would not be surprised to discover large shareholders are asking him to rethink the European drive, something which may explain his willingness to take another job.

A new chief executive officer is likely to undertake an immediate review of the business. Domino’s has already subtly scaled back its UK roll-out programme this year. The new boss will have to give clarity on the reasons behind this, be they planning difficulties, distractions from European expansion or simply over-ambitious expectations. A clear strategy would help to regain investor support.

The delays in Europe and reduced expansion in the UK are already factored into analyst forecasts and the share price, which is down by a third from May’s 707.5p year-to-date peak. Even with these lower expectations, Domino’s remains a cash machine. The dividend is forecast to rise by 25% over the next two years. At 463.6p, the FTSE 250 stock offers a 3.6% prospective yield for 2014.

DOM - Comparison Line Chart (Rebased to first)

N+1 Singer reckons Domino’s will generate £43.2 million post-tax profit in 2014 and £48.9 million in 2015. ‘The possibility of all this being returned to shareholders is very real given the balance sheet is 0.4 times leveraged and importantly there appears to be no significant capex requirements on the horizon,’ it says. The broker reckons 70% will be paid through dividends, the rest via share buybacks.

Panmure Gordon believes the management hiatus could trigger a private equity approach ‘given that net to EBITDA of under one times compares to DPZ (US parent) which has circa five times’. It reckons a reduction in the pace of growth could result in special dividends for shareholders.

Buy

The shares are trading at their lowest point since May 2012 and fully discount the disappointment about expansion challenges and management uncertainty. Consensus remains bullish and we are inclined to agree.

STRENGTHS

• Highly cash generative

• Robust balance sheet

• Strong brand

WEAKNESSES

• Management hiatus

• Overseas roll-out troubles

• UK roll-out delays

OPPORTUNITIES

• Raise cash returns

• Refocus on UK

• More innovative locations

THREATS

• Drop in
consumer confidence

• Food price inflation

• Prolonged CEO search

Pie dominoes

Broker consensus strip



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