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Randal Jenneke, T Rowe Price

Following its fall from grace in 2016, Australia’s largest pizza chain Domino’s Pizza Enterprises became one of the most shorted stocks on the ASX. Now sentiment appears to be turning back in its favour, with fund manager T Rowe Price declaring itself a buyer and Macquarie Securities restoring the stock to ‘outperform’.

Domino’s share price climbed steadily from around $2.50 in 2009 to $10 in 2013, before taking off in 2014 and hitting a peak of $75.80 in August 2016.

Domino’s missed earnings guidance when it announced its 2016/17 results and flagged relatively weak earnings growth for 2017/18. Earnings per share grew 20.1 per cent in 2016/17, down from 46.2 per cent the previous year and 35 per cent in 2014/15

And in 2017, Fairfax Media reported wage fraud in the Domino’s franchise network and a business model that encouraged franchisees to cut corners, such as underpaying workers. Domino’s denied the claims.

It fell back to a low of $40.43 in April this year before starting its recovery. The stock is now back around $50.

T Rowe Price Australian Equity Fund portfolio manager Randal Jenneke says Domino’s is an ‘A stock’, putting it at the top of its ratings system. But the challenge for an investor was that it was expensive.

“The company has long-term appeal but it also had some issues. We have not owned it until recently. When the share price got down to $40 a share we became a buyer,” he says.

Domino’s is gathering support in other quarters. After dropping it from ‘outperform’ to ‘neutral’ in August last year, Macquarie Securities restored the stock to ‘outperform’ in June, saying its upgrade was based on the risks to the company’s business being less than previously thought.

Domino’s Pizza Enterprises holds the master franchise agreement for the Domino’s Pizza brand in Australia, New Zealand, Japan, France, Belgium and the Netherlands. Australia is the fourth largest market for Domino’s, after the United States, the United Kingdom and Mexico.

In March this year, the Parliamentary Joint Committee on Corporations and Financial Services launched in inquiry into the operation and effectiveness of the Franchising Code of Conduct.

Macquarie says: “The outcome from the franchising inquiry can be expected to be a net negative for franchisors, yet we suggest that outcome will be manageable for Domino’s.
Macquarie also believes the company is developing a strong base in Europe, which will produce scale benefits.

“In our view 2018/19 PE of 25 times provides valuation support for a business we expect to grow in excess of double-digits per annum, with a path of medium-term earnings revisions potentially skewed higher.’

The T Rowe Price Australian Equity Fund has a concentrated portfolio with 30 to 35 stocks (33 currently). It has a high active share, which means that its stock holdings differ significantly from index weights.

“It is a quality growth strategy – quality companies with high rates of growth. We look at a company’s ability to grow, how it deploys its capital and how it reinvests,” Jenneke says.

For the year to the end of June, the fund produced a return of 14.5 per cent (13.8 per cent net of fees), compared with the return of 13.01 per cent for the S&P/ASX 200 Accumulation Index.

Over the past three years the fund has returned 11.5 per cent a year, compared with 9.04 per cent a year for the index.

Other companies T Rowe Price Rates highly include the medical technology company Resmed and the building products company James Hardie, which is one of the fund’s biggest positions and one of its best performers over the past few years.

“We like companies with strong offshore earnings,” Jenneke says.