Cube Midcap Report (15 Oct 2020) – Dunelm & Domino’s are WFH winners

Cube Midcap Report (15 Oct 2020) – Dunelm & Domino’s are WFH winners

Good morning, it’s Roland here with the Midcap Report.

I’ve got trading updates from two companies on my list today — I’m aiming to take a quick look at each.

  • Domino’s Pizza Group (DOM)
  • Dunelm (DNLM)

Domino’s Pizza

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Market cap £1.7 billion
RNS Q3 trading update
Writer disclosure No position.

The appeal of Domino’s slick online ordering and rapid delivery service is pretty obvious in a world where millions of us have been working from home and in lockdown.

System sales (the value of total store sales) in the UK and Ireland rose by 18.7% over the summer quarter and are up by nearly 10% year-to-date:

DOM Q3 update 2020

As you can see from the figures above, performance has improved significantly versus the same period last year.

One area of contention among investors and franchisees in recent years has been over how much expansion potential remains. Domino’s 1,100+ UK store estate means that new stores are generally opened by splitting existing franchisees’ territories into smaller areas.

However, new openings have been limited over the last six months and the figures above reflect this – like-for-like sales growth is almost equal to total sales growth.

Orders are down

The system sales figures above might make you think that Domino’s total order numbers have risen this year. That’s not the case. The company appears to rely more heavily than I realised on collections, which have recovered partially but still remain at approximately 60% of pre-Covid levels. The shortfall in collection sales has had a big impact on total orders, although this has partly been offset by price increases.

As we can see in the table below, total orders have fallen in both Q2 and Q3. But revenue in Q3 was been boosted by an average price increase of 12.6%: [UPDATE: Also fair to point out that the average order size, measured by items per order, has increased. So people are making fewer, larger orders. I guess that’s consistent with being at home versus — say — picking up a pizza on your way home from the pub]

DOM Q3 FY20 sales breakdown

My view

I’m not sure how much this year’s exceptional circumstances tell us about Domino’s remaining growth potential in the UK and Ireland.

The ongoing issues with franchisees relating to the level of profit sharing between Domino’s and its shop operators also remain a concern. In today’s update the firm only says that it’s seeking a “realignment with our franchisee partners”, but that ongoing discussions could take some time.

Overall guidance for the current year is in line with current consensus for a pre-tax profit of £93m-£98m, according to management. This prices the stock on about 22 times 2020 forecast earnings, with a 2.5% yield.

If Domino’s can resolve the issues with its franchisees, I think the shares could be reasonably valued at this price. In recent years, this business has generated returns on capital in excess of 30% and healthy cash flow. I remain cautiously optimistic, on a long-term view.

Dunelm Group

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Market cap £3.2 billion
RNS Q1 trading update
Writer disclosure No position.

Dunelm doesn’t have issues with franchisees or cannibalisation of its existing stores. But as with Domino’s, the volume of its sales has been affected by lockdown restrictions and the resultant lack of in-store shoppers. Total sales fell by 4% during the year to 27 June 2020.

However, since stores reopened in June, in-store sales have been strong. We already know from a prior update that sales in July and August where ahead of expectations. Today’s first-quarter update provides a more complete view on this:

DNLM Q1 FY21 update

There’s good news on profits, too. Gross margin for the first quarter rose by 1% due to a reduction in discounting. The company expects full-year gross margin to be “slightly positive”, barring any further COVID-19 disruption.

My view

I think Dunelm’s stores probably benefit from typically being located on retail parks, rather than in shopping centres. Reports from big landlords such as British Land (I hold) suggest that these out-of-town locations are trading much better, as they lend themselves better to social distancing and travel by car.

Management say that trading in the first quarter was ahead of expectations and cite a “resilient” outlook for the homewares sector. But they note that the uncertain economic outlook means that the potential range of outcomes for FY21 is “unusually wide”, leaving them “unable to provide any meaningful guidance”.

I find this a little hard to swallow after all this time, especially when this statement is compared to the detailed scenarios provided by rival retailer Next (which also sells homewares). I’d be staggered if Dunelm’s management haven’t costed out various scenarios for the year ahead. Why not share these? We’d all understand that they might be subject to revision.

Despite this frustration, I continue to view this as a good quality business with attractive prospects. In recent years Dunelm has reliably generated strong returns on capital and double-digit operating margins. The balance sheet looks strong to me, too.

Right now, I’d suggest that this good news is mostly in the price. The stock trades on 28 times forecast earnings and I note that the price has flatlined this morning, despite the strength of the firm’s figures. I wouldn’t rush to buy into Dunelm at the moment, but I continue to view the business as one of the better retail stocks and potentially a good long-term investment.

That’s all for today — thanks for reading.




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