The full year profit from Domino's Pizza Enterprises Ltd. (ASX: DMP) may be more than wiped out if the worst-case scenario from the class action brought against it by staff and delivery drivers is successful, warns Citigroup.
Shareholders can at least take some comfort that the warning didn't stop the stock from bouncing from the four-year low it crashed to yesterday on news of its legal trouble with the Domino's share price jumping 1.7% to $36.90 on Wednesday when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index fell 0.3%.
The recovery is small comfort though given the more than 7% plunge in the stock yesterday and the estimated $240 million profit wipe-out from Citigroup won't help sentiment either.
Legal loss could wipe out FY18 profit and then some
To be sure, the broker thinks it's unlikely that a legal defeat would cost that much and the figure reflects the maximum damage that can be inflicted by the class action on Domino's bottom line.
That's good because the amount is nearly as much as the company's FY18 earnings before interest, tax, depreciation and amortisation (EBITDA) and significantly more than its adjusted net profit of around $157 million.
The class action was filed on behalf of staff employed by Domino's franchisees between June 24, 2013 and January 23, 2018.
Domino's is accused of misleading franchisees by advising them to pay delivery drivers and in-store workers under a series of incorrect employment agreements when they should have been paid under the Fast Food Industry Award 2010, according to the Australian Financial Review.
"The claim relates to employment law in Australia more broadly and therefore it is hard to find a precedent. Any estimate we make is subject to revision, but as a guide, we estimate the cumulative store wages paid over the period would have been $1.0-$1.2 billion," said Citi.
"The difference between the award and Domino's agreement could have been 10%-20% given it primarily relates to late night, weekends and driver allowances. The value at risk if every employee, from every store were party to the action would be $100-$240 million, plus any interest or other ancillary damages."
Bad news more than factored into share price
This amount equates to $1.17 to $2.80 per share and given that the stock crashed by $2.83 yesterday, it implies that the market expects the worst-case payout from Domino's.
Citi thinks this is overdone and has reiterated its "buy" recommendation on the stock with a price target of $44 per share.
"This class action has weighed on the share price. However, the scope is very large and it seems a stretch that the market would fully factor in this risk in the share price," said the broker.
"Moreover, the issue is historical, will not persist as Domino's now pays the Fast Food Award in Australia."
