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From The Survey: Dunkin’ Brands Group
Dunkin’ Brands Group (DNKN), dating back to the 1940s but public in its current form since mid-2011, is one of the world’s leading franchisors of quick-service restaurants, serving hot and cold coffee and baked goods, as well as hard-serve ice cream. As of the end of the third quarter, its nearly 100% franchised business model included approximately 10,800 Dunkin’ Donuts restaurants and 7,100 Baskin-Robbins ice cream shops that were spread across almost 60 countries. The company is headquartered in Canton, Massachusetts, and has annual franchisee-reported sales of about $9 billion.
The stock has been a standout over the past year, rising more than 50%, thanks to strength across the core Dunkin’ Donuts U.S. segment, which accounts for around three-quarters of the revenue mix. Indeed, that unit, surprisingly resilient against an uneven macroeconomic backdrop, continues to outperform many other fast-food outfits that cater predominantly to lower-income consumers. Additionally, we expect this trend to persist throughout 2014, with same-store sales apt to track in the 3% area. (They were up a particularly robust 4.2% in the September interim.)
Apart from a firmer domestic economy, including a brightening jobs picture, comps will be lifted, we think, by higher menu pricing, brisk K-Cup single-serve coffee sales (pursuant to an agreement with Green Mountain Coffee Roasters (GMCR)), product rollouts (the breakfast sandwich platform has been a runaway hit), and stepped-up marketing initiatives aimed at using social media (e.g., Facebook (FB) and Twitter (TWTR)) more effectively. A newly debuted loyalty program, called “Dunkin’ Donuts Perks,” should also drive customer counts and prove to be a nice complement to the mobile payment application that was introduced over a year ago. Starbucks (SBUX), one of the company’s key rivals, along with McDonald’s (MCD – Free McDonald’s Stock Report), has had a “Gold Card” rewards plan in place for a while now. And the “Perks” program, to be launched nationally in the first quarter, should help Dunkin’ Brands better compete with this sector heavyweight for market share in the high-margined coffee space.
Notably, the company’s franchised business model gives it a leg up on most of its quick-service rivals. That’s because the predictable, capital-light model, whereby almost all units (over 99%) are run by franchisees, enables management to focus on menu and advertising strategies that will add to the brand’s appeal. It also minimizes fixed overhead costs and shields the company from unfavorable commodity fluctuations. And the scheme allows Dunkin’ Brands to rapidly extend its concepts using other people’s money.
To this end, the company is committed to aggressively expanding its flagship Dunkin’ Donuts chain on the home front, with square footage growth likely to approximate 5% in 2014 and beyond. Historically, the lion’s share of restaurants have been located along the Northeast Corridor, meaning that the chain has really been far more regional than national in nature. That’s likely to change, however, as current development plans call for a big, multiyear push out west. In fact, openings throughout the western part of the country, in densely populated regions of California, Colorado, and Utah, should eventually enable the Dunkin’ Donuts U.S. store base to reach 15,000 units, up from just over 7,500 today.
Overseas expansion is also a priority, but the smaller Baskin-Robbins concept, rather than Dunkin’ Donuts, ought to take center stage. Baskin-Robbins’ domestic track record has been spotty, at best, partially due to the fact that many of the ice cream shops are run by “mom and pop” franchisees with limited industry experience. A store transfer program is beginning to garner benefits (seasoned franchisees with deeper pockets are being encouraged to take over underperforming locations), however, and other operational initiatives, from an enhanced product pipeline and advertising campaign to a new standardized technology platform, suggest that a long-awaited turnaround may be in the works. At the very least, a more stable U.S. ice cream business appears likely.
In the meantime, the Baskin-Robbins system is shining on the international scene, most notably in Japan, Korea, and Middle East. In fact, the Baskin-Robbins international segment is the company’s second-largest profit engine, owing to strong unit development and solid same-store sales growth in the low single digits. And we expect it to become even more important over time, particularly as the restaurant operator oversees store-level margin gains and sets its sights on the huge Chinese market.
In terms of finances, the company is in decent shape. It does carry a fair amount of debt on its balance sheet, with the debt-to-capital ratio now upwards of 80%. Yet, free cash flow is rather strong, a testament to Dunkin’ Brands’ low-capital-intensity franchise model. This permits the company to pay a moderate $0.76-a-share annual dividend, which equates to a yield of about 1.6%, a bit under the Value Line median. Dividend hikes seem probable in the years ahead, too, with an acceleration in unit development expected to lead to a nice jump in distributable cash flow.
In sum, there’s a lot to like about the Dunkin’ Brands story. The stock has run up quite a bit, however, and now looks relatively expensive on a forward P/E basis. (The forward P/E multiple is around 29 at present.) Still, long-term investors are advised to keep an eye on this equity, since successful brand extensions at home and abroad could well render our 3- to 5-year estimates rather conservative. A share-price pullback could well materialize during a market correction, too, which would give buy-and-holders an opportunity to accumulate this unique restaurant name.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.