Dunkin' Brands Group, Inc. (DNKN) has been a star since the IPO on July 26, 2011, with the stock up 30.26% versus the broad market being down 6.58%. For those unfamiliar with the business, a spin off from a consortium of private equity firms that acquired the company in December 2005, DNKN, through franchising Dunkin' Doughnuts locations, is selling doughnuts, coffee and breakfast at more than 9,900 distribution points. In addition, DNKN owns Baskin-Robbins franchise of ice cream stores, with 6,625 points of distribution. Generally speaking (as a consumer), the coffee is good, the doughnuts are, too (they are not as good as Krispy Kreme Doughnuts, Inc. (KKD), but very little is) and so far as ice cream is concerned Baskin-Robbins is ok too.
The stock, however, is vastly overpriced based upon the underlying fundamentals and is a clear short. As I detailed in my blog on November 19, there are four principal reasons that an investor should consider shorting DNKN, with a price objective of $13.00 per share.
- Didn't we learn, in 2008, that you don't pay a premium for highly levered companies? DNKN is almost 5.0x levered, with $1.5 billion of debt in the form of a term loan that matures in 2017. The balance sheet affords little to no flexibility, and as the term loan is priced at an attractive Libor +300, when there is a refinancing, the single-B rated DNKN will see a meaningful uptick in borrowing costs. The significant debt burden, combined with around $100 mm per year of FCF (which won't make a substantive dent in the debt burden annually) creates limited financial flexibility to consider meaningful buybacks, dividends or other shareholder initiatives.
- The company has shown no growth, with EBITDA of $271.4 mm, $270.3 mm and $276.3 mm, for the years ended 2008, 2009 and 2010, respectively. While consensus has the company showing 10% growth in 2011 and 2012, the ability to post sustained growth should not be paid for now in a premium multiple (13.17 EV/Next Year's EBITDA). To compare, Starbucks Corp. (SBUX), a consistent winner with no net debt, a committed management (more later) and a track record of growth is trading at 10.25x on an EV/Next Year's EBITDA basis. Another competitor, McDonald's Corp. (MCD), is trading at 10.53x on an EV/Next Year's EBITDA basis. DNKN is not in their league, and should be discounted based on the financial and operational track record, not trade at a premium.
- The owners are selling (the private equity consortium still owns 60% of the outstanding shares, but have punted the 40% relatively quickly (first in the IPO, and then another 22 mm shares a few months later). I am not sure it is prudent to be the buyer when the smart money (who owned, and knows, the underlying business, is selling). Further, management and certain officers had the lock-up restriction waived to sell stock quickly. That's pretty unusual (I haven't seen it before).
- DNKN innovates nothing. The company is selling doughnuts, breakfast foods and coffee through a franchise business model. SBUX, MCD and a ton of other regional competitors are out there competing in this business, and in many cases, doing a great job. DNKN is excited to grow by entering new markets outside the traditional Northeast. While the coffee and doughnuts are fine, people won't be lining up in anticipation of a DNKN coming to town (as the local SBUX is probably doing a good job).
Based upon the aforementioned, this stock should be trading at 9.0x, using what feels like a very aggressive 2012 estimate, DNKN is worth a bit more than $13.00 per share. This stock is priced wrong, coming off the excitement of the IPO. Short the stock. These doughnuts are priced to perfection. A missing sprinkle, and the whole story goes stale.