09/30/13 Covered Call Pick: Dunkin' Brands Group Inc. (DNKN)
Dunkin' Brands Group Inc. (DNKN) is a retail restaurant company that runs two different restaurants in coffee shop and doughnut giant Dunkin' Donuts, and ice cream shop, Baskin-Robbins. With over 17,500 franchises in the U.S. and across 55 foreign countries, this Canton, Massachusetts based company had a franchisee-reported sales total of nearly $8.8 billion at the end of 2012.Dunkin' Brands has a market capitalization of $4.82 billion with 106.4 million outstanding shares.
DNKN currently pays a $0.19 quarterly dividend for a current yield of 1.7%.
With a beta of 0.73, DNKN currently trades with approximately 70% of the market's volatility.
Dunkin' Brands has been performing admirably since the summer of 2011 when it went public, and has recently taken the markets by storm. Over the past year, the stock is up over 41% as compared to the S&P 500 which has gained only about 15% in that same time. Normally when we do these recommendations, we start off talking about the story behind the business, and why it is/will be successful. This time though, we are going to focus more on the stock itself. The business is fantastic, with great global exposure, ample growth plans, and great brand recognition. Also, who doesn't love coffee, doughnuts, and ice cream? So let's focus on the stock and fundamental numbers a bit to see why DNKN should find a place in your portfolio.
Despite the stock's wonderful 1-year return, the company is still projecting double-digit EPS growth for the next two years: 20% in 2013, and 19% in 2014. The company's ROE is a powerful 27%, the third highest among mid-cap restaurants. The company also plans to add 17 locations in the western and central part of Texas as it continues its search for the West Coast.
Have we forgotten to mention that DNKN hasn't even made it out to California yet?
The company still has HUGE domestic growth potential, as well as plans to return to carving out a foothold in the United Kingdoms. The future earnings growth potential in the stock is wonderful, which can be very rare for a company that already has such strong brand recognition.
Because of the strong gains in the stock over the past year, one of the important questions we have to address is valuation. The trailing 12-month P/E ratio is 32, right in the middle of the stock's historical P/E Range. Out of context, this is expensively priced according to many classical fundamental valuation theories. But when we take the valuation in context with the company's growth prospects it becomes less of a concern. If we calculate the forward-looking P/E ratio based off of 1-year projected EPS estimates, we get a P/E ratio of 24, which is much more reasonably priced given the company's growth. The 1-year PEG ratio also comes in at 1.99, which does not indicate that the stock undervalued, but more reasonably valued than what current estimates give us. Now these forward-looking valuations are subject to the risk that the company fails to execute, or economic risk comes in and gets in the way of what helps the company reach those estimates. We do believe though that between the management's ability to execute, and the sheer amount of growth potential available to the company especially in the domestic market, will help the stock continue to grow through the next two years. Just be aware, there is a measure of added risk in using valuations on forward-looking estimates.
While DNKN's slogan, "America Runs on Dunkin" is true about their coffee, which anyone in the working world considers a necessity rather than a discretionary, the remainder of DNKN's products can be considered "extras" in the world of the American consumer. What is a positive note for DNKN though, is the fact consumer spending rose in August by 0.3%, mainly off of higher wages which drove income up 0.4%. While the gains remain modest, extra spending cash in the pockets of American consumers can help drive discretionary sales that could help benefit DNKN moving forward (if they continue to execute). While consumer sentiment slid in September to the lowest in five months due to the dysfunction in Congress, higher interest rates, and what could be a sluggish economic growth story, the sentiment does not seem to effect spending as much as expected, mainly due to income growth. With the pickup in income growth, we could see consumption growth accelerate into the end of the year, which can help not only the economy, but again discretionaries like DNKN.
In the near term, DNKN has a bit of downward momentum it is working against, not helped by threat of a government shutdown pressuring the market. That said, the stock is reaching its pivot point after small period of consolidation, while being supported by its 50-day moving average. If it is able to survive the bearish sentiments coming out of the market due to the looming shutdown, it is very likely it will break out of its pivot point to the upside, creating strong upward momentum. Because we believe in the story of DNKN for the long term, and because we believe even if the market is sent downward due to a shutdown, once it is sorted it will bounce back fairly quickly, we are looking for an out-of-the-money Covered Call on DNKN. This will still give us growth potential in the stock while providing some downside protection by going out to March of 2014. That is why we are recommending buying DNKN and selling the March 2014 $50 Call.
Scenario:
- Buy 100 shares of DNKN @ $44.89 = $4,489 + Commission ($12.95) = $4,501.95
- Write 1 DNKN March 2014 $50 Call @ $1.00 - Commission ($8.70) = $91.30
Note: Prices may vary from the time of post. Actual commissions paid will vary returns.
Static Return (Not Called):
(Call + Dividend)/Stock Price X (Days/Year)/Days to Expiration
(0.91) + (2*0.19)/45.02 X (365)/172
= 6.08% Static Return
If-Called Return:
(Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration
(0.91 + (2*0.19) + 50 - 45.02)/45.02 X (365)/172
= 29.55% If-Called Return
Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarantee the above, or any, result. All investment decisions should be made based upon individual's personal investment goals and risk tolerance.
Posted by OaktreeAdvisors at 9/30/2013 9:50 AM 
Categories: Weekly Picks
Disclosure: I am long DNKN.
Additional disclosure: As active managers we may add DKNK to our portfolios and write options in accts when suitable and will sell when we believe appropriate.