Dunkin Brands: High on Donuts

By Ashish Sharma - July 9, 2012 | Tickers: DPZ, DNKN, MCD, SBUX, YUM | 0 Comments

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Dunkin Brands Group Inc (NASDAQ: DNKN) has posted a good 39% returns year to date. The company with its 100% franchise model generates a relatively stable and significant amount of free cash flow. Nearly 81% of the company’s sales were generated by the Dunkin Donuts brand in 2011 and 19% of sales were outside the United States. The four segments that Dunkin Brands operate in are Dunkin Donuts U.S., Baskin Robbins U.S., Dunkin Donuts International and Baskin Robbins International. The following is a break up of revenue and total units among these businesses.

The company reported strong Q1 results with a profit of $26 million, or $0.21 a share, compared with a year-earlier loss of $1.7 million, or $0.51 a share. Excluding the debt costs, amortization and other items, earnings per share rose 150%, from $0.25 from $0.10. Revenue grew 9.5% to $152.4 million. U.S. same-store sales rose 7.2% at Dunkin Donuts stores and increased 9.4% at Baskin Robbins stores. Long-term growth is expected to be largely driven by Dunkin Donuts’ franchisee expansion into the largely untapped Western U.S., emerging eastern market and international expansion of both brands (Dunkin Donuts & Baskin Robbins).

Huge White Space Opportunity in US

Dunkin Donuts has a huge white space opportunity in the U.S. market, which is unique among its large cap peer group. Dunkin Donuts U.S., which represents more than 74% of the revenue, has close to 85% of its approximately 6,800 domestic locations in core and established markets. Also the population per store in emerging and western markets is too high. The number of stores and population per store data is summarized in the following table.

Such low level of penetration in emerging and western markets offers Dunkin Donuts U.S. a large white space opportunity in these markets and going forward these untapped markets will drive strong growth for the company.

International Unit Growth Opportunity

Unit growth opportunities are also solid in international markets, where the Baskin-Robbins brand is stronger. Dunkin Brands is entering India at a time when it's aiming to rapidly grow its presence in the Asia-Pacific region, to take advantage of a rapid rise in incomes. Dunkin Brands already runs 473 Baskin Robbins ice-cream parlors in India and has announced to set up 500 stores over the next 15 years.  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. India's cafe market is expected to grow more than 250% by 2016 (from $190 million to $680 million). The company, with already 80 Dunkin Donuts and 120 Baskin Robbins outlets in China, aims to open 250 stores in the country over the next four years.

As a result, Dunkin Donuts International is expected to grow with over 200 units a year (accounting for nearly 7% unit growth) for the next few years.  Baskin Robbins International is expected to add 250 new units a year (accounting for nearly 6% unit growth) for the next few years.

High Sales to Investment Ratio

Dunkin Brands franchised business model is characterized by small capital requirements leading to significant and growing levels of free cash flow. Dunkin Donuts has average sales of about $900,000 per location (excluding gas and convenience store locations) and average build‐out costs around $461,000. This results in impressive sales to investment ratio of 2. Also the company has cash-on-cash returns around 25%. Dunkin Donuts’ strong store‐level economics have played a key role in attracting and retaining successful franchisees. The continued improvements in profit per location and encouraging cost metrics are likely to result in accelerated unit expansion in coming years.

The other positives include implementation of a new POS system that will drive franchisees’ margins, $100 million targeted cost saving plan and a new long‐term supply chain agreement with National DCP, which will yield greater consistency in supply and distribution service levels as well as new cost efficiencies for franchisees.

Valuation and Recommendation

The following table compares Dunkin Brands relative valuation versus its peer group.

Although Dunkins is trading at a premium to its peer group and may appear overvalued, one needs to understand the opportunity ahead for Dunkin is far higher than any other company in the above table. McDonald's, Yum Brands and Domino's already have a significant presence globally -- both in developed as well as emerging markets like India and China. Therefore their store growth potential is limited. On the other hand Dunkin does not have enough penetration in many US geographies (particularly west), let alone the international ones. This means in addition to Same Store Sales growth, new store openings will be another big drivers of Dunkin's growth story. 

We expect DNKN’s premium valuation to sustain as the company is well positioned to gain market share in the coming future. The company also has an attractive business model with various opportunities to improve profitability through technological and operational advances. We recommend Dunkin Brands as a core long-term holding for investors’ portfolio.

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