Should I Buy DNKN? 3 Pros, 3 Cons

by Tom Taulli | October 28, 2013 9:49 am

Should I Buy DNKN? 3 Pros, 3 Cons

dunkin donuts coffee e1304523003986 Should I Buy DNKN? 3 Pros, 3 ConsDunkin Brands (DNKN[1]) reported earnings last week, but DNKN results fell short.

Dunkin earnings tallied 41 cents per share — a nearly 11% year-over-year increase, but two pennies short of expectations. DNKN also noted that its full-year adjusted earnings per share will likely be at the low end of its $1.50 to $1.53 range.

Investors shrugged off the news, though, with DNKN stock holding onto its gains to the tune of a 47% year-to-date climb. One reason was that the company continues to rack up nice same-sales growth. In Q3, DNKN same-store sales beat expectations with a 4.2% improvement.

But can DNKN keep up the momentum? To see, here’s a look at the pros and cons:

DNKN Pros

Powerful Business Model. For the most part, DNKN relies on a franchise strategy. While there are some risks with this approach — such as with quality control — it is a great way to accelerate growth. That’s because Dunkin Brands does not have to pay for the upfront capital costs of launching a new location, so operating income margins are juicy for DNKN. In Q3, they came to nearly 48% on an adjusted basis. Plus, DNKN has a predictable recurring revenue stream, which is something Wall Street loves.

Growth Opportunities. A good chunk of DNKN locations are on the east coast, but that means the company has plenty of room to expand. The move to the west coast is still in the nascent stages, but DNKN is already making inroads into states like Colorado, Texas and California. In fact, Dunkin thinks it can reach 15,000 restaurants — double the 7,500 it has today. And on the DNKN conference call, CEO Nigel Travis said there continues to be strong interest from prospective franchisees.

Marketing Savvy. The “America Runs on Dunkin” campaign has been quite a success, helping to drive traffic and brand awareness. Plus, DNKN recently launched a new social media campaign to help build up its fan base. The commercials are based on comments from Facebook (FB[2]) and Twitter posts, and initial feedback shows the ads are resonating with customers. DNKN is also in the early stages of rolling out its DD Perks loyalty program, which will provide attractive offers and discounts and is connected to the company’s mobile app.

DNKN Cons

Competition. The industry is crowded with players like 7-Eleven (which just redesigned its stores), Quick Trip and WaWa. Plus, McDonald’s (MCD[3]) has been getting aggressive with its coffee offerings. At the same time, there is more pressure on the bakery-goods business of DNKN. For example, La Boulange from Starbucks (SBUX[4]) will likely be a large competitor, while SBUX is already a clear rival on the coffee side of things.

International. The international business has been weak for DNKN, with same-store sales down 1.4% for the most recent quarter. Sure, part of this was the result of bad weather in Japan. But there are also indications of management problems as well, as seen in Korea and Spain. As a result, DNKN says it will devote more resources to marketing, operations and better menu items to get things back on track … but it’s not certain those costs will pay off.

Valuation. Shares of DNKN stock are a somewhat pricey, trading for over 27 times forward earnings. This is is in-line with rivals like Krispy Kreme Doughnuts (KKD[5]) and Starbucks. But if DNKN has troubles expanding on the west coast or shows any other signs of slowing down, the stock could be vulnerable.

Verdict

DNKN definitely has a strong platform. The franchise strategy has been a great way to keep up the growth and allow for high operating margins. Plus, Dunkin sells low-ticket items that are part of the daily habits of millions of customers. In other words, it’s the kind of business that tends to be resistant to economic slowdowns.

But the real reason to like Dunkin is the fact that it still has tremendous and obvious growth opportunities. This is not the case with other companies, like Starbucks and McDonald’s, which may have reached saturation levels.

In light of all these factors, the pros outweigh the cons on DNKN stock.

Tom Taulli runs the InvestorPlace blog IPO Playbook[6]. He is also the author of High-Profit IPO Strategies[7]All About Commodities[8] and All About Short Selling[9]. Follow him on Twitter at @ttaulli[10]. As of this writing, he did not hold a position in any of the aforementioned securities.

Endnotes:
  1. DNKN: http://studio-5.financialcontent.com/investplace/quote?Symbol=DNKN
  2. FB: http://studio-5.financialcontent.com/investplace/quote?Symbol=FB
  3. MCD: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCD
  4. SBUX: http://studio-5.financialcontent.com/investplace/quote?Symbol=SBUX
  5. KKD: http://studio-5.financialcontent.com/investplace/quote?Symbol=KKD
  6. IPO Playbook: http://investorplace.com/ipo-playbook/
  7. High-Profit IPO Strategies: http://goo.gl/TXQsz
  8. All About Commodities: http://goo.gl/FfP8R
  9. All About Short Selling: http://goo.gl/t5Jzb
  10. @ttaulli: https://twitter.com/ttaulli

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