Dunkin' Brands: A Good Long-Term Buy

By Gayatri Sharma - August 15, 2012 | Tickers: DF, DNKN, YUM | 0 Comments

• Email
• Print

Last month Dunkin' Brands Group (NASDAQ: DNKN) reported mixed 2Q results. Same store sales at Baskin-Robbins International (1.5% vs. 4.8% consensus estimates) and Dunkin’ U.S. (4% vs. 5.3% estimates) were disappointing, but better-than-expected sales at Baskin-Robbins U.S. (4.6% SSS vs. consensus estimates of 3.7%) and Dunkin’ International (3.5% SSS vs. consensus estimate for 2.6%) helped mitigate their effect. With strong dynamics and recently taken supply chain initiative, I continue to like the long-term story. I believe that the company is well positioned to generate mid to high single digit top-line growth and average 20%-plus EPS growth annually over the coming years.

Major Supply Chain Initiative

The company has decided to close its Peterborough, Ontario, Canada ice cream manufacturing plant and shift production to a trusted long-term dairy manufacturing partner, Dean Foods (NYSE: DF). Currently, the Peterborough plant supplies ice cream to about one-third of the brand's international locations, which represent more than half of this business segment's profitability. A significant factor in the closure decision is that this plant has not been able to deliver the increasing need to provide ice cream to a growing number of international franchisees and their customers.

I believe that moving international ice cream production will provide more opportunity to innovate Baskin-Robbins flavors and ice cream products. Moreover, the potential to manufacture at additional Dean Foods plants will support continuity of supply and future growth. As a result of switching production plants, the company will generate significant annual saving ($4-5 million or about $0.02 per share beginning in 2013). Further, I expect the company’s greater focus on core skills of franchising, retail and product innovation, rather than ice cream production, will lead to impressive results in the beginning of 2013.

Aggressive Expansion in International Markets

Unit growth opportunities are impressive in international markets like India and China. For example, India’s coffee market is expected to grow more than 250% by 2016 (from $190 million to $680 million). Currently, coffee consumption is 100 grams per person each year in India, compared with 4.5 kilograms in the U.S., providing plenty of room for growth.

The following table summarizes the percent gain in international sales of Quick Service restaurants like McDonald's, Starbucks, Dominos, Tim Hortons and Yum! Brands (NYSE: YUM)-owned KFC over the year.

YOY change in International Sales FY11-12

Clearly, Dunkin' is gaining substantial consumer traction globally through its Baskin-Robbins segment. This is a huge positive for the company as a meaningful amount of profits in the restaurant space is being generated internationally. China alone generates 40%+ of Yum’s worldwide profits, with the U.S. generating about one-quarter of Yum’s global income. Such easily visible growth in the Baskin-Robbins segment could help keep investor interest in Dunkin' high.

Visible Expansion for Donuts

In 2Q12, the company opened 71 gross restaurants, which was in line with last year. Of the openings, 33% were in core markets, 25% in established markets, 33% in emerging markets and 9% in the West. I see a nice opportunity for Dunkin' to continue broadening its footprint in the West and ultimately make it a bigger contributor to Dunkin's overall results.

In the domestic circuit, Dunkin' Donuts has much more brand presence in the east than the west. There's roughly one Dunkin' Donuts store in the northeast for every 9,700 residents, compared with one for every 1.2 million people in the West. As such, if Dunkin' Donuts is able to build a positive brand presence west of the Mississippi River, then it could enjoy enormous sales growth over the years.

Over the long run, Dunkin' Donuts aims to reach 15,000 domestic distribution points, substantially in the West. Although this is very much a long-term goal, the company has taken recent steps to lay the groundwork to achieve it.

I believe Dunkin’ has good share gain prospects with continuous long-term unit growth opportunity, SSS gains and larger franchisee transactions to accelerate growth. The company currently trades at forward PE of 21.16, which is relatively higher among its peer group (eg. Tim Hortons and McDonald's are trading at a forward PE of 17.13 and 14.66, respectively). However, its valuation seems justified as the continued improvements in international sales in both segments and encouraging cost metrics are likely to result in accelerated unit expansion in coming years with impressive profits. Thus, I recommend it a buy for the long term.

• Email
• Print
• Feedback