Why You Should Avoid This Coffee Chain Over The Long Term

| About: Dunkin' Brands (DNKN)

In the recent Mad Money show, Cramer cited his agreement with portfolio manager Ed Ponsi's view that the stock of Dunkin' Brands Group (NASDAQ:DNKN) is poised for an upside. Ponsi's argument is based on the fact that the stock's 50-day moving average has been serving as a solid price support since the beginning of 2012. The price chart below shows that there has been five times that the stock price tried to drop pass the 50-day moving average, but eventually bounced back.

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I somewhat agree with their bullish view, but only on a short-term basis. Over a longer investment horizon, I believe DNKN's lofty valuations are difficult to be supported by the company's current strategy and fundamentals. In this article, I will illustrate the rationales behind.

My value analysis includes Starbucks (NASDAQ:SBUX) and Tim Hortons (THI) as DNKN's comparable peers. The calculated valuation is determined by weighting five different valuation multiples from the group - EV/Sales, EV/EBITDA, P/S, P/E, and EV/FCF. As the companies in the analysis are relatively established and EV/EBITDA, P/E, and EV/FCF appear to be more relevant in this case, they are assigned a higher weight of 25% each. And the less relevant EV/Sales and P/S are weighted 12.5% each.

At $31.78 per share, DNKN is trading at 15.0x the NTM EBITDA and 24.9x the NTM EPS. Accounting for its growth estimates, the stock trades at a PEG of 1.5x, higher than the peer average of 1.4x. Compared to SBUX and THI, although DNKN's top line is likely to experience a slower growth ahead relative to the group average, its EBITDA and EPS growth are likely to be faster. DNKN also has superior profitability margins, however it has lower investment return metrics like ROE and ROIC (see comparable analysis table below).

In terms of liquidity, the firm's robust FCF margin is another bright spot, as its 18.5% level is a lot higher than the group average of just 7.6%. Due to a much higher leverage level, DNKN's interest coverage rate as well as current and quick ratios are all below the group averages (see comparable analysis table below).

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As such, it would still make sense for the stock to trade at premium over its peer average. According to my model, the current stock price implies a valuation premium of 16.4% over the five peer average multiples (see relative valuation table below), suggesting the price is not overly expensive given that the company remains in a robust growth stage.

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Thus, over the short term, the 50-day moving average may continue giving a solid support to the stock price. But it will not last forever.

Compared to SBUX, DNKN's growth potentials appear to be mediocre. Although its EPS is forecasted to grow at a much higher rate, the top line and EBITDA growth estimates are significantly lower. This is also reflected by SBUX's higher YTD same-store sales growth at 8.0% vs. DNKN's 7.2%. Most critically, DNKN's growth strategy is primarily limited to the US market while SBUX is growing internationally with about 25% of total revenues coming from foreign countries. Over time, DNKN's growth tends to be less sustainable given its less diversified market presence. Nevertheless, DNKN is still trading at a 2.8% premium above all of SBUX's five valuation multiples (see comparable analysis table below).

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Bottom line, given that DNKN's valuations remain affordable and there is a strong technical price support, I would recommend only a risky short-term speculative buy. Over the long term, I am not a buyer of the stock until I see any material improvement in DNKN's growth strategy.

Price chart is sourced from Capital IQ, analysis tables are created by author, and all financial data is sourced from Morningstar and Capital IQ.

Disclosure: I am long SBUX, THI.

Additional disclosure: I have no plan to establish positions for DNKN.