Not Quite Good Enough
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When Dunkin' Brands (NASDAQ: DNKN) initially went public, I was very excited about the company's prospects. With family from New England, I've been introduced firsthand to the kind of brand loyalty that the Dunkin' Donuts chain has in this part of the country. If you ask the average New Englander if they want coffee, most will assume that you're getting something from Dunkin' Donuts. If the company is able to spread this kind of brand loyalty worldwide, this could be an excellent long-term investment. However, some of the numbers that the company reported in their recent earnings release just were not quite good enough.
The company's revenues increased by nearly 10%, and adjusted EPS grew by 32%. If you dig a little deeper into the earnings report, it seems as though the company is not being aggressive enough in opening new stores. Dunkin' Brands is essentially two large chains that are competing with multiple well-established competitors. The Dunkin' Donuts chain is in direct competition with companies such as McDonald's (NYSE: MCD) and Starbucks (NASDAQ: SBUX). In a strange twist, the Baskin-Robbins chain also competes with McDonald's and Starbucks as all three companies offer multiple dessert type options. At this point, the market seems to expect greater growth from Dunkin' Brands than the company is indicating. Let's look at each of the two large divisions separately to get an idea of the type of growth investors can realistically expect.
Dunkin' Donuts is the true growth driver for the company. The stores are small enough to be located almost anywhere, yet of the over 10,000 total locations most are domestic, and East of the Mississippi River. Dunkin' Donuts is expected to expand both domestically and internationally as it believes this concept translates well worldwide. The challenge with having already over 10,000 locations is the company has to open a lot of new stores to get a big boost in earnings growth. Unfortunately, it doesn't appear the company is willing to expand as fast as some might have hoped. Just for point of reference, Starbucks plans to open about 1200 new locations, which equates to roughly 7% new store growth. If Dunkin' Donuts opens the roughly 500 new stores they expect, this would account for about 5% new store growth. When your primary competitor is opening more new locations, and already has 76% more locations than you do, investors aren't going to be pleased.
When you consider that a chain like McDonald's operates over 30,000 locations and is planning on opening hundreds internationally, you can see that Dunkin' Donuts is nowhere near its saturation point. In addition, same-store sales both in the US and internationally were not particularly impressive. In fact, the company's performance was very similar to the larger McDonald's with between 3.5% and 4% growth. In total, 5% growth in new stores and the company's guidance for 4% to 5% same-store sales growth for the year equates to at best 10% total growth from the Dunkin' Donuts chain. Looking at the Baskin-Robbins chain, the growth numbers are even lower.
Baskin-Robbins is one of the most well-established names in the ice cream industry with over 6,800 total locations. However, the company appears to have a challenge with same-store sales growth at least in its international units. In the most recent quarter, U.S. comparable sales increased 4.6%, while international comparable sales increased just 1.5%. The company strategy is to slowly close underperforming U.S. stores, while opening new stores overseas. In fact, the company expects to close between 40 and 60 U.S. Baskin-Robbins stores and open around 225 new locations internationally. If you aggregate these two numbers, investors should only expect about 2.4% new store growth from this half of the company. With same-store sales growth expected between 2% and 4%, total growth could be as low as 4.4% or as high as 6.4%. Baskin-Robbins faces some serious competitive pressure from both McDonald's and Starbucks especially in the international markets. In fact, McDonald's operates many standalone dessert only stores in both Europe and the Asia-Pacific region. Now that we've looked at both halves of Dunkin' Brands, let's see how the company stacks up next to its major competitors we've already mentioned.
Dunkin' Brands is calling for revenue growth of between 7 and 8%, and analysts expect long-term earnings growth of about 16.4%. While these numbers are not bad, the fact that the stock sells for over 24 times forward earnings estimates makes it seem a bit expensive considering the alternatives. For example, Starbucks sells for nearly the same P/E ratio and yet has a much higher expected growth rate of nearly 20%. McDonald's on the other hand, is not expected to grow quite as fast at roughly 10%, but the company pays a superior 3.2% yield. In addition, McDonald's has the advantage of huge free cash flow, and has proven its willingness to increase the dividend on a regular basis. This leaves Dunkin' Brands shareholders somewhat caught in the middle between the higher growth Starbucks option and the better yield of McDonald's. While Dunkin' Brands could be a great growth story, the company is going to need to open more new locations to make this happen. Specifically, the Dunkin' Donuts chain needs much faster growth in order to compete effectively with Starbucks and McDonald's. Unless Dunkin' Brands management speeds up the development of the Dunkin' Donuts chain, I think either Starbucks or McDonald's represent better options.
MHenage owns shares of McDonald's. The Motley Fool owns shares of McDonald's and Starbucks. Motley Fool newsletter services recommend McDonald's and Starbucks. 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.If you have questions about this post or the Fool’s blog network, click here for information.