James Faulkner on DP Poland: Grab a pizza the action

It’s funny how much money there is to be made in something as mundane as pizza! Since its IPO on AIM back in 1999, the UK incarnation of Domino’s Pizza (DOM) has grown to encompass more than 800 stores, with annual sales of almost £667 million. With the shares now at 676p, anyone lucky or clever enough to have bought shares at the IPO price of 17p would now be sitting on a profit of 3,876%, assuming no profit-taking along the way but also not taking into account dividends paid. For anyone who got in at the all-time low of 10p, the figure is a staggering 6,660%!

Domino’s Pizza UK & Ireland continues to churn out some tasty growth figures here, but I think we can safely assume that the days of the really big gains are behind us – after all, there’s only so much pizza a country can eat.

But there’s one stock trading on AIM that is rolling out the Domino’s brand in a land where the convenience food industry is only just finding its feet.

DP Poland (DPP) operates in a market of 40 million which managed to remain relatively unscathed by the financial crisis. Although Poles do not yet enjoy Western European living standards, they are catching up relatively quickly, and the convenience food market is a major growth area. For example, McDonald’s added 25 new outlets in Poland in 2013 alone, up from 131 company operated outlets previously. Given what we know about Domino’s business approach, the following comments from Euromonitor International are noteworthy: “Online orders are likely to be increasingly popular due to easier procurement systems through online portals and the implementation of online ordering systems by fast food operators via their websites.” So what’s not to like?

A classic case of inflated expectations

At the time of the IPO in 2010, management aimed to roll out 50+ Domino’s Pizza stores in 4-5 years, predominantly in Warsaw, with a wider national roll out and sub-franchising to be considered later in the development programme. From an IPO price of 50p, the shares initially soared to 120p as punters rubbed their hands together in expectation of a repeat of the UK success story. However, as it became obvious that proving the model in Poland would take longer than first envisaged, the shares began to drift lower, eventually hitting an all-time low of 7.625p in 2014. By 31st December 2013, DP Poland was operating from 6 corporate stores and 1 sub-franchised store in Warsaw and 2 corporate stores in Krakow – a far cry from the targets envisaged at the time of the IPO. The group also made an EBITDA loss of £2.8 million in 2013, on revenue of £3.2 million. Not exactly pretty numbers.

But this doesn’t mean that investors should write off DP Poland just yet. It is worth bearing in mind that Domino’s Pizza UK & Ireland shares drifted substantially lower before they began their long bull run, and these things take time to gain traction. One major plus point is the fact that DP Poland has a management team with a strong track record. CEO Peter Shaw is a veteran of the Polish food industry, having been part of the management team which built up former AIM listed business coffeeheaven, which managed to achieve a 23% share of the Polish market before the business was sold to Whitbread for £36 million in 2010. Maciej Jania, Managing Director of DP Polska, was also part of the founding team at coffeeheaven.

Is DP Poland approaching an inflection point?

A significant milestone was reached in the fourth quarter of 2014, when total store EBITDA turned positive for each month during the quarter. In addition – and here’s the crucial bit – DP Poland reported that “the stores recently acquired by our first franchisees are performing well, exhibiting strong sales growth and generating profitable commissary sales of food and non-food items for DP Polska.”

The key to Domino’s success in the UK has been the fact that it employs a ‘capital-light’ model in that it uses other people’s money to grow the business via franchising licences. Essentially, the franchisee pays Domino’s a fee for using the brand, and in return Domino’s provides the marketing infrastructure and supply chain. The beauty of this arrangement is that the more successful the advertising, the better the franchisees perform; the better the franchisees perform, the more royalty income is received by Domino’s; and the more royalty income is received by Domino’s, the more money it has available for marketing. Now that DP Poland’s first franchisee appears to be doing well, one would hope that other potential franchisees will be drawn in, thus driving the virtuous circle described above.

Is now the time to take a slice?

Sorry about the pun (had to get that in somewhere). With Q4 being the ninth consecutive quarter of double-digit like-for-like sales growth, and current trading also looking strong (LFL system sales +18% in January), it appears that DP Poland now has considerable momentum behind it. The top three stores returned an average EBITDA of £24,000 over 2014 and house broker Peel Hunt reckons the Q4 run rate would have been close to £40,000. With just two stores opened in 2014, it is clear that cost cutting has played a major role here, as DP Poland decelerated its rollout programme in order to get its house in order. However, with nine stores expected to be opened in 2015, the outlook is one of expansion again.

In terms of valuation, the company is still well away from a point where any conventional metrics can be applied. However, Peel Hunt anticipates a net cash position of c.£4 million for the end of 2014, which is not inconsiderable versus a current market cap of c.£9 million. Eventually, the broker envisages DP Poland operating 200+ stores, which suggests EBITDA of £8 million+ is achievable longer term. The potential for a multi-bagger is there, so long as management can maintain the momentum.