Quick service restaurants (QSRs) are hot today, but the stock of Dunkin' Brands (Nasdaq:DNKN) hasn't enjoyed as much of that love. While owners of McDonald's (NYSE:MCD), Yum! Brands (NYSE:YUM), Panera (Nasdaq:PNRA) and Starbucks (Nasdaq:SBUX) have all racked up double-digit gains over the past year, Dunkin' has been an under-performer.
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The trouble for Dunkin' stock right now seems to be the trade-off between quality and value. There are a lot of things to like about the business model at Dunkin' Brands, but working off a demanding valuation may keep a lid on outperformance for a little while yet.
A Solid End to the Fiscal Year
By and large, Dunkin' had a solid end to its fiscal and calendar year. Reported revenue rose almost 13%, or 7% when adjusted for the extra week. System-wide sales were similarly solid - up 15% as reported and up 8% on an adjusted basis. Revenue growth was certainly boosted by better than expected comps - with Dunkin' Donuts up more than 7% and Baskin-Robbins surprisingly up almost 6%.
Profit performance was not as strong. Although "adjusted" operating income was reported up more than 31%, there was barely any operating income by GAAP standards. All in all, while the company did beat on the top line, it basically just met the expectations on an adjusted basis. (For related reading, see What Are Some Of The Key Differences Between IFRS and U.S. GAAP?)
International Results Were Weak Tea
Although Dunkin' Brands does not report international comps, a rough guess based on available information would suggest that Dunkin' Donuts was weak (perhaps down slightly), while Baskin-Robbins was up at a healthy mid-single digit clip.
Frankly, it was the international operations that sapped the company's earnings momentum and operating leverage. Operating profits at Dunkin' Donuts international looked pretty weak, with South Korea apparently being the big area of weakness.
An Attractive Model
There's a lot to like about the Dunkin' Brands' concept right now. The franchise model can support rapid unit expansion without straining the company's cash flow or balance sheet, while delivering the high unit growth and high margins that restaurant investors seem to love. With Dunkin' having only minimal exposure west of the Mississippi, that could be a major growth driver. (For related reading, see The Essentials Of Corporate Cash Flow.)
I also think Dunkin' will likely try to drive greater menu expansion in its Dunkin' Donuts store. Dunkin' Donuts is a big player in the breakfast market, but those stores are comparatively idle for the rest of the day. If Dunkin' can take a page from Panera or Subway and offer solid sandwich and quick meal options that appeal to the lunch and dinner customers, there could be some significant operating leverage.
Dunkin' also has a very strong base overseas, with a lot of units in Japan and South Korea. While Dunkin' is not even close to Yum! Brands in China, this is clearly a high-priority target for future expansion. Just as international growth has been a big boost for YUM and McDonald's, the same could be true over time with McDonald's.
The Bottom Line
Unfortunately, even for all of the good things about the Dunkin' Brands model, it's very hard to get excited about these shares at current valuations. Growth investors probably won't care, and I understand the points they would likely make in regard to unit growth, comp store growth and international expansion fueling many years of double-digit operating income growth.
That said, I think Dunkin' Brands is priced for perfection in an increasingly competitive breakfast QSR and retail coffee market. With expectations for over a decade of solid double-digit growth already baked into the price, I'll just stick with the coffee and donuts for now.
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.
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