Fed’s Next Moves & Domino’s Pizza Stock Analysis

Archive edition · Market data and company circumstances reflect 24 August 2024, when this newsletter was sent.

Federal Reserve's July Meeting

The Federal Reserve's recent meeting in July marked a significant moment for US monetary policy.

While the central bank ultimately decided to keep interest rates unchanged, the minutes from the meeting revealed a growing consensus among policymakers that a rate cut might be appropriate in September.

Potential Policy Shift in September

The minutes from the Federal Open Market Committee’s (FOMC) July meeting indicate that most participants are leaning towards a policy easing at the next meeting, provided the economy continues on its current trajectory.

While all members supported maintaining the fed funds rate in July, several pointed to recent inflation and labor market data as justification for a possible rate cut.

The debate within the Committee highlights the balancing act between preventing a premature easing that could reverse progress on inflation and avoiding a scenario where delayed action weakens economic activity or employment.

The discussions took place prior to the release of a weaker-than-expected July employment report, adding further complexity to the decision-making process.

Labor Market Observations

FOMC participants noted improvements in the balance between labor supply and demand. Many observed that payroll job growth might be overstated and could be lower than the breakeven rate needed to keep unemployment steady.

The boost in labor supply, attributed to elevated immigration and higher prime-age labor force participation, has likely contributed to this improved balance.

However, concerns remain. Some participants warned that a gradual easing in labor market conditions could lead to a more severe deterioration if not carefully managed. Overall, the recent economic data was largely in line with the Committee's expectations.

Implications for the Economy

The staff's economic forecast for the July FOMC meeting was revised downward due to weaker-than-expected labor market indicators.

The projection now anticipates a positive but narrower output gap by early 2025. The unemployment rate is expected to rise slightly for the remainder of 2024 and remain steady through 2025 and 2026.

Inflation forecasts have also been adjusted slightly lower, with headline and core PCE inflation expected to reach around 2% by 2026.

The staff characterized the uncertainty around this baseline projection as consistent with the average over the past 20 years, with risks skewed towards higher inflation but lower economic activity.

Domino’s Pizza: Buy, Hold or Sell?

ASX listed Domino’s Pizza Enterprises (DMP) has reported its 2H24/ FY24 results, showcasing a mixed bag of performance metrics and strategic shifts.

The company managed to deliver in-line results, but with notable variations across different regions and segments. Below, we break down the key takeaways from the report, the outlook for FY25 and beyond, and what it all means for investors.

Store Closures and Growth Strategies

DMP announced plans to close more stores in Japan and France, primarily in the first quarter of fiscal year 2025. This strategic move aims to improve store profitability and network quality.

Despite these closures, the company expects network sales per store to start increasing from the second quarter of 2025.

To fuel growth, DMP plans to increase its media spending. This investment will likely lead to higher operating expenses in the first half of 2024, but it's expected to drive improved year-on-year growth from the second half of 2025 and into fiscal year 2025.

Financial Outlook

Goldman Sachs has updated its financial outlook for Domino’s Pizza Enterprises (DMP), reflecting a cautious stance for the next few years.

They now anticipate lower network sales and compressed EBIT margins, driven by factors such as store closures in key markets like Japan and France, as well as increased media spending to boost brand visibility.

Despite these near-term pressures, DMP’s EBIT margin is projected to improve over time. This improvement is expected to come from a strategic shift towards a higher proportion of franchise stores, which typically deliver stronger margins compared to corporate-owned stores.

As DMP continues to streamline its operations and refocus on core market strengths, Goldman Sachs sees potential for earnings recovery and growth in the medium to long term. The revised outlook suggests a temporary dip in profitability, followed by a more sustainable path to enhanced margins and overall financial health.

Goldman Sachs forecast Group EBIT margin of 9.8% in FY25 improving to 11.0% in FY26.

As DMP continues to streamline its operations and refocus on core market strengths, Goldman Sachs sees potential for earnings recovery and growth in the medium to long term. The revised outlook suggests a temporary dip in profitability, followed by a more sustainable path to enhanced margins and overall financial health.

Pizza Profits Still Cooking

Goldman Sachs remains bullish on Domino's Pizza Enterprises (DMP), maintaining a "Buy" rating with a target price of A$40.00 per share. This represents a potential upside of 24% from current levels.

The target price is based on a combination of valuation methods:

Overall, Goldman Sachs' valuation reflects their confidence in DMP's ability to execute its growth strategy and deliver strong financial performance.

• Sum of the Parts (SOTP): This approach values each of DMP's regional operations separately and then combines the values to arrive at an overall valuation. Goldman Sachs assigns different valuations to regions based on their specific market conditions and growth prospects.
• Discounted Cash Flow (DCF): This method projects DMP's future cash flows and discounts them back to their present value using a discount rate that reflects the company's risk profile.

Archive note

This article preserves the analysis in our weekly newsletter sent 24 August 2024. Market prices, forecasts and company circumstances reflect the time of publication and may have changed.

This material is general information, not personal financial advice or a recommendation to trade. Investing and trading involve risk, including loss of capital.