Get It Straight - This Is A Coffee Company

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Dunkin Brands (NASDAQ: DNKN) is a coffee company that happens to sell doughnuts and ice cream. How can I make this assertion? Let me ask a question to answer that question. Have you ever asked a New Englander why they go to Dunkin Donuts? I'd be willing to argue that they say it's for the coffee. Since the company grew up in Massachusetts, it makes the most sense that people from that area know what Dunkin Donuts (aka. Dunkin Brands) is all about. This is the key to understanding the company's opportunities, and to correctly valuing the stock. However, along the way some popular myths about Dunkin' Brands have come up. Let's take a few of these myths to task.

Myth #1 – Dunkin' Brands primarily sells doughnuts

I read an article after Dunkin' Brands went public, where fellow fool Rick Munarriz bashed Dunkin' Brands. He suggested that, “selling coffee and doughnuts isn't as dramatic a breakthrough model as Dunkin' investors seem to think.” The big issue I had is, he compared Krispy Kreme (NYSE: KKD) to Dunkin' Brands. The problem is while Krispy Kreme gets about 80% of its sales from pastry sales, Dunkin' gets about 60% of its revenues from beverages. The other big difference between the two companies? How about the huge difference in what their food offerings are? Comparing the two companies information online, Krispy Kreme shows only one food product – doughnuts. Dunkin' Donuts on the other hand, shows 13 different types of food items from cookies, danishes, muffins, bagels, and sandwiches. So let's also straighten that out, Krispy Kreme sells doughnuts, Dunkin' sells many types of food. However, coffee is their main attraction.

Myth #2 – Dunkin' Brands can't compete with Starbucks

So if Dunkin' Brands, through its Dunkin' Donuts stores sells many types of food, and also sells multiple variants of coffee, I wonder what other company this sounds like? To me, the more appropriate comparison for Dunkin' Brands would be to Starbucks (NASDAQ: SBUX). Both companies have strong brands, both companies sell pastries, sandwiches, and other foods, as well as coffee. Starbucks currently sells for about 30 times earnings, and is expected to grow by about 19%, for a PEG of 1.58. Dunkin' Brands sells for about 24 times earnings, and is expected to grow at 15%, for a PEG of 1.60. Starbucks has 60% company owned stores in the U.S. and about 40% franchised stores. By comparison, nearly all of Dunkin' Donuts locations are franchised stores. In theory, this gives Dunkin' Brands an easier road to expansion as the company isn't risking as much of its own capital in building out stores. With most Dunkin' Donuts stores east of the Mississippi, there are significant expansion opportunities inside the U.S. Both companies have just scratched the surface of their international potential. Starbucks has about 3,800 international locations, versus Dunkin' Donuts has about 3,000 locations. In its core markets in New England, if someone calls home to ask if they should pick up coffee, they are usually talking about Dunkin' Donuts. As Dunkin' Donuts expands west of the Mississippi, more customers will realize they can not only order in English (as opposed to Fritalian), but also pay about 13% less than Starbucks for the same size cup of coffee.

Myth #3 – Dunkin' Brands balance sheet is bad and will only get worse

I've heard multiple times that Dunkin' Brands balance sheet is a problem. While I would agree the company has more debt than I would like to see, this issue is being addressed. Look at the direction of Dunkin' Brands cash, long-term debt, and shareholders equity in the last year:

(numbers in thousands)

Quarter

Cash

Long-Term Debt

Shareholders Equity

1

$153,295

$1,853,322

-$549,367

2

$176,045

$1,850,586

-$547,892

3

$208,845

$1,477,348

$733,237

4

$277,732

$1,458,272

$745,936 

I see a clear pattern of cash going up, equity going up, and long-term debt going down. Considering the company generated about $144 million in free cash flow over the last 4 quarters, it seems like the company is doing fine.

Conclusion

Dunkin' Brands is a coffee company that happens to sell other products. The fact that they expand through franchisees, avoids the company going into more debt. They have tons of expansion potential inside the U.S. and internationally. The company is addressing their balance sheet issues, and generating free cash flow. While I wouldn't say the stock is a screaming buy, the company deserves more respect than it currently gets. Use this information as a starting point for your own research, and see if DNKN deserves a spot in your portfolio.


Motley Fool newsletter services recommend Starbucks. The Motley Fool owns shares of Starbucks. MHenage has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

blog comments powered by Disqus

Compare Brokers

Fool Disclosure