Share of the week: Smell the profits at Domino's Pizza

Domino's Pizza wasn't the biggest riser in the FTSE 350 index this week. That title goes to Abu Dhabi-based Al Noor Hospitals, the subject of a bid battle which sent its share price up as much as 24%. But the phenomenally successful pizza chain is our favourite after a tasty set of third-quarter results delivered 21% returns over the past five days.

In truth, this shouldn't be surprising. Domino's has been one of the stockmarket's all-time great performers, rising from an adjusted flotation price of 15.625p in 1999 to a high of 1,064p this week. It had 894 stores at the end of 2014 compared with 190 when it listed on AIM and 501 when it moved to the Main Market in 2008. Another 50 will be opened this year.

But the company continues to confound the analysts. "Very strong" third-quarter numbers and a "solid" start to the fourth quarter mean full-year results will now beat expectations. That forced a further round of profit upgrades in the City, only three months after the last rush of upwardly-revised estimates following bumper half-year figures in July.

This time, rapid growth in online orders generated UK sales of £200 million in the 13 weeks to 27 September, up 14.9% on a like-for-like basis. This was the eighth consecutive quarter of double-digit growth and sales are now up almost 12% over the nine months at £597 million.

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Domino's, which also delivers in Ireland, Germany and Switzerland, has spent heavily on its digital business and apps, and currently sponsors the Hollyoaks TV show. Apparently, it "enhanced brand saliency and drove revenues". Well, something worked because online sales soared by 35%, and over three-quarters of delivered sales were ordered online. Some poor summer weather certainly helped.

"We enter the final quarter of the year with good momentum, are confident of beating our previous expectations for the full year and remain excited about our longer term growth prospects," said chief executive David Wild.

Douglas Jack at Numis Securities now thinks Domino's will make a pre-tax profit of £68 million in 2015, 5% more than his previous estimate and up 24% on the year before. Jack had already raised forecasts by 3% after the interims. If the numbers come in as expected, like-for-like sales will rise 10.5%. Forecasts for both 2016 and 2017 rise by £4 million.

At 998p, Domino's trades on almost 30 times Numis estimates for earnings per share of 33.4p this year, although that drops to 27 times forecasts for 2016. That's eye-watering in anyone's language, but Jack thinks there's mileage here. The UK firm historically trades on about 24 times earnings anyway, and Domino's US is on 33 times. At Domino's Australia it's 47 times. Gulp.

The current rating "does not fully reflect the ongoing upgrade trend and the pace/quality of earnings," argues the analyst. It's why Jack now thinks the shares are worth 1,100p, up one pound from his previous target.

They may well trade that high some time, who'd bet against them given the company's impressive financial performance and growth on offer? According to the relative strength index, the shares are temporarily overbought. However, in recent years that has tended to wash through over time without any significant sell-off. Given the healthy economic outlook for consumer spending, successful digital offering, and potential to improve overseas stores, it would seem sensible to tuck into Domino's on the dips.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.