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Bears Could Get Scalded as Dunkin Stock Brews up More Gains

Dunkin stock will continue to delight its shareholders

dunkin stock

Source: Chris Waits Via Flickr

Dunkin Brands (NASDAQ:DNKN) has surprised a lot of people since its IPO back in 2012. At the time, many observers felt that Dunkin was a washed up or tired brand. People weren’t buying the growth strategy that Dunkin was selling. Interest in the IPO was modest, and Dunkin stock didn’t do much initially.

Come 2013, however, Dunkin’s growth plans started to pay off, and Dunkin stock soared 50% on the year. Things went quiet for the next few years, but since 2016, Dunkin is back at it again.

The company has enjoyed another big round of earnings growth. And with its most recent quarter, Dunkin has gotten costs under control.

That led the company to a great situation, where it is quickly growing top-line revenues and also expanding its profit margin. Not surprisingly, the stock has advanced again to new all-time highs. And there could be more to come.

M&A Speculation

The coffee space has been on fire in recent years. Private equity has been keen to bid for just about anything that would give it a leg up in coffee sales. In recent years, we saw Panera Bread go private at a seemingly exorbitant price.

And that was topped by the jaw-dropping bid to take Keurig Green Mountain Coffee private. JAB Holding agreed to pay nearly double the then-prevailing market price for Keurig’s stock, stunning analysts.

Keurig was a consensus short sale position among many popular bearish hedge funds and investors, as its Cold machine was widely expected to be a commercial flop. It went on to underperform, as expected. Yet, JAB still paid up for Keurig, motivated by the chance to get access to Keurig’s highly popular K-cup technology and brand.

That brings us forward to today. JAB, which has holdings all across the coffee business, is reportedly on the hunt for another acquisition.

Some analysts have suggested that Dunkin Brands could be their next target. Also, rumors are floating about saying that Swiss conglomerate Nestle (OTCMKTS:NSRGY) could be interested as well.

The Bet Against Dunkin Stock

At the time Keurig Green Mountain was acquired, short sellers had a truly massive position in the stock. They thought it was a big short moment. Instead, they got run over. Dunkin Brands is setting up a potentially similar situation.

Superstar short seller Jim Chanos declared earlier this year that he’s been shorting both Dunkin and Restaurant Brands (NYSE:QSR), which runs Burger King and Tim Hortons.

Chanos presented his thesis, suggesting that restaurants that franchise out all their locations are overvalued. He noted the wide discrepancy in stock performance between restaurant chains that own their own stores and those that use franchisers to operate their stores.

Chanos said that if you look at restaurant operators, they are struggling. Due to rising food costs, higher minimum wages, and so on, margins are sinking. More and more franchisees are barely making ends meet.

He pointed to the difference in performance between Restaurant Brands stock and that of its largest franchisee, Carrolls Restaurant Group (NASDAQ:TAST). At the time, TAST stock had been performing poorly indeed.

However, in recent months, TAST stock is now up 50% off its lows. It is joined by a host of other restaurant stocks that have shot to the moon this year, as rising consumer confidence, the corporate tax cuts, and normalizing food prices have given new energy to the sector.

At this point, it appears that franchisees, if not exactly prospering, aren’t in as terrible a situation as Mr. Chanos had previously thought.

Shorts Heading for a Green Mountain Repeat?

This potentially puts Dunkin stock short sellers in a difficult place. Chanos suggested that Dunkin would struggle expanding outside of the northeast, particularly if it continued passing along higher fees to its franchisees.

However, earnings reports for Dunkin haven’t shown a significant slowdown in the business. At least so far, it appears that Dunkin’s cost structure is still providing a win-win for both the parent company and its operators.

The most recent quarterly results showed this playing out in practice. The company swung back to positive same-store sales, with the figure up more than 1% at its Dunkin Donut locations.

That’s not a huge number, but it beats flat to slightly negative results of recent quarters. And on the flip side, cost inflation has let up. In fact, coffee futures have tumbled to their lowest level in more than a decade.

Add it up, and Dunkin Donuts scored a healthy 60 basis points margin expansion for the quarter, helping Dunkin stock power to fresh new highs.

In a recent interview, Dunkin’s CEO Nigel Travis gave his take on Chanos short thesis:

“What he [Chanos] doesn’t get is that we have a beautiful [business] model, we have a brand that we constantly try to refresh based on what the consumer wants… I find it hard to understand his thesis.”

Dunkin Stock Verdict

At 31x times trailing earnings and 25x forward, Dunkin stock isn’t especially cheap, but the company has fantastic growth potential. In the U.S., it still sees its ultimate store count doubling as it moves more aggressively out of its traditional home base in the Northeast. Internationally, Dunkin also seems to be finding a market.

In the country where I reside, Colombia, for example, Dunkin has grown far more quickly than Starbucks (NASDAQ:SBUX). Dunkin is able to set up in lower-cost environments, such as bus terminals, whereas Starbucks business model, so far, has only thrived in a few wealthy Colombian neighborhoods.

While Starbucks earns fatter margins, as Dunkin expands to developing markets, it should be able to sell far more coffee by honing in on the mass market.

Short sellers have bet heavily against Dunkin stock, taking almost 9% of the float short. That is dangerous. JAB Holding has shown that it is willing to pay up for coffee acquisitions before.

At this price, Dunkin would hardly be a stretch compared to past deal valuations. And even if Dunkin isn’t acquired, its earnings growth is fast enough to support its $75 share price.

While the stock may consolidate for a bit after its big move, the odds favor more upside ahead for Dunkin.

At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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