3 Things That Make This Stock a Slam Dunk

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

I think that a lot of people mis-understand Dunkin' Brands (NASDAQ: DNKN). I know some people personally who assume that Dunkin Donuts is everywhere and that the Baskin-Robbins chain has reached its saturation point. The problem with these assumptions is they are thinking of the east coast of the United States and not beyond that point. Dunkin' Brands locations are mostly located east of the Mississippi. In fact, the company has said in the past it expects to double the Dunkin' Donuts presence in the United States just by expanding westward. Beyond our borders, each concept is already established across the globe and it will be years before either chain reaches saturation worldwide. While some would worry about the global appeal of competitors like Starbucks (NASDAQ: SBUX) or McDonald's (NYSE: MCD), much like in the U.S. it seems there is plenty of business to go around, and Dunkin' Brands' recent earnings just proved that point.

While some investors might look at Dunkin' Brands revenue growth of 4.7% in the last quarter and yawn, there is much more to the story than just revenue growth. The company's Dunkin' Donuts chain saw same store-sales growth in the U.S. of 2.8% and 2.1% growth overseas. Baskin-Robbins saw same-store sales growth as well with an increase of 1.1% domestically and a 3% increase internationally. For those who are worried about the concepts reaching saturation, consider that the company opened 3.9% more Dunkin' Donuts and 4.5% more Baskin-Robbins on a year-over-year basis. While all of these numbers are respectable, there are three keys to why Dunkin' Brands could be a better investment than its competition.

EPS growth

Many investors look for EPS growth as a way to gauge an attractive investment, and Dunkin' Brands is generating impressive growth indeed. In the last three months, diluted EPS increased 32.14% on a year-over-year basis. This was the second quarter in a row of over 30% EPS growth, and while analysts don't expect quite this fast pace of growth in the future, Dunkin' Brands might surprise some people. Analysts are calling for nearly 17% EPS growth from the chain over the next few years. While this might not sound as good as Starbuck's projected growth of 17.93%, or Panera Bread (NASDAQ: PNRA) at 19.32%, the company's performance versus estimates says analysts may be surprised. In fact, look at the relative performance of each of Dunkin' Brands' competition if we adjust for how much each has beaten earnings over the last four quarters:

Name

EPS Growth Expected Next 5 Yrs

Avg. Beat Last 4 Quarters

Adjusted Growth Rate If Avg. Beat Continues

Dunkin' Brands

16.98%

4.25%

17.70%

McDonald's

8.41%

1.18%

8.51%

Panera

19.32%

3.20%

19.94%

Starbucks

17.93%

0.60%

18.04%

(*source Yahoo Finance – Analyst Estimates – calculation is = growth rate * 1 + avg. beat %) 

As you can see, if you adjust for the amount Dunkin' Brands has been beating estimates, the company's future growth rate could end up much closer to Panera and Starbucks and easily outpaces McDonald's.

Gross Margin

One area where Dunkin' Brands leaves its competition in the dust is their gross margin. The reason is simple, Dunkin' Brands is run by almost 100% franchised restaurants versus a combination of company-owned and franchised stores at their competition. Since the company has this built in advantage, their gross margin last year was over 80%. By comparison, Starbucks' gross margin is 57.70%, Panera showed a 52.88% margin, and McDonald's came in last with a 39.57% gross margin. Quite simply it's easier for Dunkin' Brands to turn less sales into more profit because they don't have the costs that their competition has to deal with. This helps explain why a small amount of revenue growth can generate big increases in EPS.

Free Cash Flow

Tied to the company's huge gross margin is their ability to generate significant free cash flow. To compare companies of different sizes, I look at free cash flow per $1 of sales to find the most efficient operator. Once again, Dunkin' Brands blows its competition away. In the last quarter, the company generated $0.68 of free cash flow per $1 of sales. Its next closest competitor was McDonald's, which produced $0.16 of free cash flow per $1 of sales. Starbucks and Panera both have strong operations, but they aren't even in the same ballpark with $0.09 and $0.07 of free cash flow by this measure.

Conclusion

While it is true that on the surface Dunkin' Brands doesn't seem like much of a deal at about 20 times next year's projected earnings, the company's huge margins, cash flow generation, and EPS growth could make all the difference. Knowing the company has ambitious growth plans might worry uninformed investors that the company would take on too much debt. However, since almost all of the locations are franchised, this expansion will happen with the franchisees money. While Dunkin' Brands won't match Starbucks or McDonald's when it comes to revenue, it doesn't matter because the company is keeping more of what it makes than these two competitors. When you put it all together, Dunkin' Brands looks like a slam dunk for long-term investors.


MHenage owns shares of McDonald's. The Motley Fool owns shares of McDonald's, Panera Bread, and Starbucks and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend McDonald's, Panera Bread, 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.

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