By Joscelyn MacKay
We're not surprised that Dunkin' Brands' (NASDAQ:DNKN) shares soared nearly 40% last week after its initial public offering before paring back recently amid mounting market macroeconomic fears. The firm has popular brands and a compelling growth story. Additionally, investors have been paying up for restaurant stocks with strong unit growth potential-- Chipotle Mexican Grill (NYSE:CMG), Panera Bread (NASDAQ:PNRA), and Starbucks (NASDAQ:SBUX) are currently trading at 46, 23, and 24 times our forward earnings estimates, respectively. While the IPO has generated significant buzz, we're concerned the market may be pricing in unrealistic expectations for the company.
We certainly buy into the firm's growth potential, as we estimate that Dunkin' Donuts can increase its store locations by 50% to around 15,000, and that Baskin-Robbins can grow its store count by nearly 20% to almost 7,700 during the next 10 years. For the current year, we anticipate consolidated revenue growth of around 10%, including contribution from nearly 1,000 new units, 3.5% comparable-store sales growth from Dunkin' Donuts, and a 1% decline at Baskin-Robbins. We've also assumed flat operating margins in 2011 as reduced administrative costs and operating leverage continues to offset elevated input costs. We expect earnings per share of $0.71 for the year, which should grow at an annual average pace of about 20% during the next five years. Still, we believe the shares are overvalued relative to our $17 fair value estimate, which implies a forward prices/earnings multiple of 24 times and an enterprise/EBITDA multiple of 12 times, slightly above the averages for Morningstar's restaurant coverage universe.
While Dunkin' Donuts has been around for 70 years, the brand has much lower penetration in the U.S. and abroad relative to Starbucks, leaving Dunkin' Donuts ample opportunity for growth, in our opinion. Dunkin' Donuts has lower penetration relative to its primary competitor, Starbucks, which has 30 stores per 1 million people according to the firm. In the Western part of the country, there is just one Dunkin' Donuts per 1 million people, providing the brand a significant opportunity for growth, in our opinion.
As with many companies, the largest potential for growth remains outside the U.S. Over the past 10 years, Dunkin' Brands has nearly doubled its store locations internationally. But, at just under 7,000 restaurants outside the U.S. (roughly 3,000 Dunkin' Donuts and 4,000 Baskin-Robbins), we believe there is opportunity for growth. Starbucks' international presence is nearly double that of Dunkin' Donuts. While we don't expect Dunkin' Donuts to grow to Starbucks' scale due to Starbucks' dominance (it represents about a third of coffee cups sold at retail), we assert Dunkin' Donuts is one of the few North American midtier chains that has realistic aspirations for international expansion, particularly in emerging markets. To be sure, Dunkin' Donuts recently signed a partnership with a local franchisee in India--where the quick-service restaurant market is growing at an estimated 30% annually--agreeing to open at least 500 stores.
We're not optimistic on all of the firm's growth plans, however. With a leading position in the sought-after breakfast daypart, Dunkin' Donuts is looking to extend its dominance into the afternoon daypart, which currently represents only 12% of sales. However, the firm is up against stiff competition. While we believe a wider product assortment will drive incremental sales, we don't believe the firm's "hearty snacks" will drive a significant increase in customer traffic. From our perspective, Dunkin' Donuts' competitors are already customers' afternoon destinations and are expanding their product assortment as well. Starbucks has recently extended its menu into all-day lunch and snacks. Another coffee chain, Caribou (NASDAQ:CBOU), is planning on offering lunch options.
Lastly, we're concerned with Dunkin' Brands' Baskin-Robbins concept--roughly a quarter of sales. While the brand is the number-one server of hard ice cream in the U.S. and has a developing presence internationally, it has had declining comparable-store sales for the past three years and we expect future growth to be soft. We were disappointed with Baskin-Robbins' 2.8% comparable-store sales decline in the second quarter after the brand's slight gain in the first quarter and the seasonal boost it should have received given the hot weather in May and June in the U.S. We view the ice cream market as highly fragmented with rapidly changing consumer tastes and preferences, a higher degree of competition, increased seasonality, and marked with frequent bankruptcies. From our perspective, these competitive headwinds will limit management's effectiveness in reinvigorating the brand through new marketing campaigns.
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