There is a piece of advice given by top UK fund manager Nick Train that can underpin an investment opportunity. “If a company owns or manufacture products that taste good it’s likely to be an excellent company”. He also suggests that “the taste of a product is something it is quite hard to imagine the internet disintermediating”.
This was my starting point in a search through the FTSE 250. It didn’t take long for me to find a company, which in my opinion makes tasty products.
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Domino’s Pizza Group (LSE: DOM) has adjusted to the Covid-19 pandemic as well as can be expected. The recent trading update showed full-year profit to be in line with consensus with a rise in recent sales. A sterling digital performance was further good news for investors. The company has also benefitted from the temporary UK VAT cut. In an interesting parallel with supermarkets, the pandemic has shifted sales more into delivery orders. The costs incurred are higher for deliveries than collections. This detracts from margins.
In my opinion, Domino’s Pizza has characteristics that should be at the forefront of a Foolish investor’s mind. Manika Premsingh examined the investing case in October. It is a resilient, cash generating business, with a strong brand. However, the recent share price trend has been downwards, suggesting investors are wary of future prospects.
Clouds on the horizon
Domino’s Pizza uses a franchise model. Usually investors have much to gain from this position. The income from each store does not have a high degree of cost attached. There is an additional revenue stream from selling equipment and ingredients to franchise owners. However, business growth depends on finding people willing to open new franchises, or expand existing ones. For Domino’s, this is a problem.
Domino’s Pizza — struggling to grow?
Domino’s strategy for growth has been to add new stores within existing franchise territories. This has resulted in more sales to customers, and ingredients to stores. New stores, however, have taken sales from existing franchise owners. Concurrently, disruption from rivals such as Just Eat has increased competition both for sales and delivery staff. CEO Dominic Paul addressed these issues in the latest update. He called for realigning the relationship with franchisee partners by agreeing a sustainable way forward. However, definitive results will take some time. There are limits to international expansion. Domino’s is also currently looking to dispose of loss-making arms in Europe.
On the surface, Domino’s Pizza looks a good prospective investment case for long-term growth. The advice given by Nick Train certainly holds up well here. Consumer tastes for the product are positive, and the dividend has been reinstated. However, there are long-term, unresolved issues beneath the surface. For now, I will be avoiding the shares.