Making Money Sipping Coffee and Dunking Doughnuts

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

America’s love for doughnuts is no breaking news. Add coffee to that and you get the perfect romance. So it makes sense to own companies that serve Americans their beloved coffee to dunk their sweet doughnuts.  

Selling coffee before doughnuts…

Dunkin’ Brands (NASDAQ: DNKN) offers customers the perfect breakfast: a cup of coffee with their favorite doughnuts and some delicious sandwiches under its brand Dunkin’ Donuts. Don’t go by the name, the company is more of a coffee house selling doughnuts, rather than the other way round.

In 2012, 58% of the sales among U.S. franchisees came from coffee and other drinks. This smart strategy is reflected in the company’s operating margin of 39.23% which is way higher than its competitor Krispy Kreme Doughnuts' (NYSE: KKD) 9.46%.

Krispy Kreme Doughnuts on the other hand is primarily a doughnuts company which sells coffee on the side. The first strategic advantage of selling coffee to attract customers is that the first thing people want to start their day is coffee not doughnuts. So Dunkin’ Donuts becomes their first choice. And after having your favorite coffee in your hand, the tempting doughnuts and sandwiches are hard to resist!

Secondly, beverages are higher margin products which explains the wide gap between the operating margins of the two companies.

Dunkin’ brands expanding west

It’s surprising to know that the successful doughnut and coffee retailer has no stores in California! Yeah…you heard me right. 98% of the stores in America are located in the northern and north eastern region, having a penetration ratio of 1:810,000 in western America compared to 1:9,300 in its core regions in the north eastern parts of the country, which means the company still has almost the entire American market left to capitalize upon!

So management now has aggressive expansion plans in western parts of the country, and states that by 2015, about two-thirds of the chain’s new U.S. stores will be in the western part of the country.

With the company already the largest retailer of coffee in the U.S., it will be exciting to see where its revenue will land when the western part of the country falls in love with the doughnuts and coffee retailer.

Starbucks (NASDAQ: SBUX), the giant of the coffee retail industry with over 18,000 stores worldwide, and probably another one opening as you read this article, has over 2,000 stores in California. Unlike Dunkin’ Brands, Starbucks operates almost everywhere in America, literally. So the company has lesser room for expansion in American than overseas, as over 75% of the revenues come from America setting the tone for overseas expansion.

Even after such a long track record of success, Starbucks is still going strong, sitting at an all time high. In their latest quarter revenue and earnings increased 11.3% and 26% respectively, while same store sales increased an impressive 6%. Analysts expect earnings to be around $2.18 for fiscal 2013 and $2.63 for 2014 putting it at a superb growth rate of 20%.

Dunkin brands new product offerings

It is important to keep surprising the customers with exciting new products in order to keep them loyal to your brand and also to attract new footfall. Dunkin’ Brands launched more than 30 new products during 2012, and its new sandwich offerings (ham and cheese, grilled cheese on Texas toast and turkey and cheddar, tuna wraps, and chicken wraps) should increase footfall at the afternoon hours which currently just account for 40% of the sales.

Aiming at the rapidly growing health conscious customers, Dunkin’ Brands is planning on selling gluten-free doughnuts and muffins starting later this year, further improving its revenue base.

Dunkin’ Brands getting a new look!

To increase traffic after the morning rush and to further gain market share from its competitors like Starbucks and McDonald’s, management has come out with a new store design after seven years and now over 70% of the stores are in the newest images.

Krispy Kreme Doughnuts offers stiff competition…

Krispy Kreme Doughnuts is undoubtedly the biggest competition to Dunkin’ Brands operating 773 stores in 22 countries. For the latest quarter revenue were up 11% to $120.6 million. What’s impressive is the 11.4% increase in same-stores, continuing the good run through the past 18 quarters. But the same-store sales numbers at international franchise stores were down 7.3%, continuing from the 8.1% fall in the quarter before that. With over 40% of the sales coming from international franchisees, this is a disturbing factor.

The company now expects its earnings per share to be in the range of $0.59-$0.63 from previous outlook of $0.53-$0.57, and the adjusted net income is expected to be between $42 million-$45 million.

Krispy Kreme Doughnuts P/E of 52.88 makes it much more expensive than Dunkin’ Brands with a P/E of 45.70. Dunkin’ Brands has a profit margin of 15.9%, thrice that of Krispy Kreme Doughnuts’ 5.08%, and also offers healthy dividend yield of 1.8%, while Krispy Kreme Doughnuts doesn’t give any dividend.

Krispy Kreme Doughnuts’ small market cap of $1.14 billion makes it prone to speculative play evident from its fall from $50 in 2004 to $2 in 2009. Therefore, I’d rather keep away from it knowing it is already up 213% from its 52-week low.

Baskin Robbins

One key product of Dunkin’ Brands which its competitors lack is its 100% franchised specialty ice-cream chain Baskin Robbins, which also happens to be the world’s largest specialty ice cream chain. The brand operated over 7000 stores in nearly 50 countries, and with summer around, the heat may keep some people from sipping hot coffee, but the ice cream segment is surely going to bring in strong revenues.

Management recently came out with an aggressive incentive plan for existing and new franchisees to attract new franchisees and remodel the existing ones to rekindle the spark in the brand. The company plans to open five new units in 2013, 25 in 2014 and 50 in 2015, which is expected to boost revenue by $93,000 in 2014 and $207,000 in 2015.

Impressive growth rate coupled with a healthy dividend

Analysts expect earnings to be in the range of $1.51-$1.55 per share for 2013 and $1.88-$1.73 per share in 2014, which puts the growth rate at an impressive 20% level.

To add a cherry on the cake, Dunkin’ Brands offers a healthy dividend yield of 1.8%. Thus, investors may earn a steady income along with participating in the company that sells their Favorite products!

Foolish takeaway

Dunkin’ Brands has a lot going for it in terms of growth. The foray into the western part of the country will unleash a new life into the brands growth in the coming five years. The new product offerings should continue to attract crowds, while their doughnuts and coffee loyal customers should remain intact. The new store designs will make the ambience all the more attractive to customers who would want to eat more slowly, enjoying the space, rather than eating on the go. And the growing Baskin Robbins chain will further strengthen the company’s portfolio. But with the price being so high, I would recommend to buy a small percentage now and wait for pullbacks to further accumulate the share.

Tushar Agarwal has no position in any stocks mentioned. The Motley Fool recommends Starbucks. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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