Dunkin' Brands Is Becoming More Attractive

Summary

• Dunkin' Brands shares have traded to new lows as the market fears about the Coronavirus intensifies.
• The company continues to perform well, but it did give guidance that came in lower than expectations.
• While shares have sold off quite a bit, I am still waiting for perhaps a better entry point.
• We look at results and where the shares may be a buy.

Source: Seeking Alpha

Dunkin' Brands (NASDAQ:DNKN) formerly known as Dunkin' Donuts, has seen its shares fall to 52-week lows along with the rest of the market as it has pulled back. While consumer buying habits keep the revenue growing, there is a fair price to pay for the rather low but steady growth. The company trades at a multiple that implies much higher growth than is forecast. While the company operates a brand that has staying power and perhaps is even recession resistant, it does not deserve such a premium in my opinion. I would love to have shares in my portfolio should they fall a bit more. The company recently cut earnings expectations and this to me means the recent sell off was warranted. Additionally, the yield would need to be higher as I look for dividend yields generally above 3% for an investment. Despite the current virus fears, I believe Dunkin' would see a limited impact unless there was massive work place and school closures. Most customers stop in due to a routine often associated with work.

Performance

Dunkin' Brands recently reported earnings that beat on the bottom line and were in line with revenue expectations.

Source: Seeking Alpha

The company reported a healthy 5.1% gain in revenue and saw earnings rise about 7.8%. The company really improved on many fronts with margin growth of 2% and higher royalty fees from its franchises. Comparable store sales for Dunkin' branded U.S. locations grew 2.1%, Baskin-Robbins U.S. comparable sales actually grew 0.8%. The company has over 9,600 stores in the United States and plenty of room to grow. Despite this large number, the company is still predominantly located upon the East coast and has plenty of room for expansion into the West.

Perhaps some of the reason that Dunkin' shares have traded at a premium higher is because of the company's limited international exposure.

Source: Earnings Slides

Right now with macroeconomic conditions looking rocky, investors are willing to pay a premium for companies with growth and strong domestic sales. However, I presume eventually that international growth will resume and this could reduce the premium investors are willing to assign to Dunkin' shares.

The company identifies its business as predictable due to the fact that its products are habitual in nature.

Source: Earnings Slides

A consumer such as myself might have a daily fix that includes a latte. Getting out of this trend of purchasing is more difficult than one would think. Additionally, Dunkin' much like its competitor Starbucks (SBUX) has a strong rewards program that has customers coming back for more and enhancing loyalty. The business also has built in growth for revenues as it has yearly price increases on the sale of its items. This should continue to help the company secure higher royalty fees as sales are destined to grow. However, i do question at what price does this fix of coffee become too high. There is a limited amount of increases that can be implemented before the consumer questions their purchasing habits. This becomes more prevalent in time of recession. With wages barely rising, and the price of goods from Dunkin' outpacing the wage growth, there will become a level where it starts to limit growth or total number of transactions. Ultimately, finding this level of equilibrium is important. While the customer may be coming for a coffee, latte, or iced tea, the purchase of a food item is what drives total ticket price higher and is usually unplanned. However, if the customer is discerned from purchasing a beverage due to a higher price, the add on purchase can never happen. This will be a big thing to watch in the coming years as I believe prices are starting to push their upper limits.

The company holds a market leading position due to heavy penetration in many of the markets it operates in.

Source: Earnings Slides

This is where the long term story may offer growth. The company is primarily focused on the East coast.

With penetration being almost non existent in much of the country.

Source: Earnings Slides

The slide points out there is about one store in the Northeast for every 9,352 persons. However, in the West this is about one store for every 189,925 people. This leaves room for the company to grow its presence to a level similar to the Northeast where it has seen its most success. The company was started in this region and it is why it is most prevalent here. However, it is important to note that the West coast is popular with many other chains and the customers are intensely loyal. They may view Dunkin' as inferior due to the craft experience these competitors offer that Dunkin' doesn't. The company plans to open 200-250 stores annually, which should provide an automatic boost to revenue as they gain traction.

Going forward the company continues to expect low single digit comparable store sales growth.

Source: Earnings Slides

The low comp sales growth combined with the lower end of the range for new stores expected to be open is part of the reason I believe shares to be expensive. The company also is not seeing much growth from its Baskin-Robbins division, in fact it appears to be a headwind to overall results. The company is only expecting $3.16-$3.21 if Non-GAAP EPS which puts the stock currently trading around $70 per share at over 22x earnings. Quite expensive in my eyes.

The company does have longer term goals which aren't that long in my opinion.

Source: Earnings Slides

The company plans to continue to grow low to mid single digits on the revenue side. On the earnings side it continues to plan to grow mid to high digits presuming no weakness in the economy. However, with shares trading at a loftier multiple, they often have further to fall should growth goals not be met.

Valuation

Looking at historical valuation we can see if the company trades above or below its average trading valuations.

Source: Morningstar

Currently, Dunkin' shares trade below their average P/S ratio, P/E, P/CF, and forward P/E. The earnings yield is however relatively low. This implies the shares are undervalued at this time, but by a relatively small margin. I prefer a 10% margin to begin a position.

Looking at the valuation compared to its main competitor in the United States, we see shares are cheaper than Starbucks.

Data by YCharts

However, Starbucks recently reported very strong comparable store sales growth that beat any expectation leading it to new highs. This does imply that if Dunkin' could pull the same feat that the shares also have room for multiple expansion. Starbucks does have greater exposure to China and other impacted areas of the Coronavirus. The results from Starbucks may actually be quite hampered this year and thus Dunkin' probably deserves a premium to its competitor in this case.

Lastly, looking at the historical yield we can see if the shares offer an above or below average dividend.

Source: Yieldchart

While the shares have only been offering a dividend since 2012, it is apparent that the shares are trading with average dividend despite the pullback and a recent raise. The average yield is 2.3%, exactly what shares are offering today. However, this does tend to be on the high side compared to its own history.

Conclusion

While Dunkin' Brands has a long runway of potential growth and sells a product that is sticky to consumers, a fair price for the shares is necessary to initiate a position. I do not believe shares should trade at a multiple above 20x earnings with the low growth that the company is experiencing. This multiple is more inline with technology company valuations. While the company offers a small and growing dividend, it is not enough to entice to me own shares at this time. I would look for the shares to pull back to a level in which they offer a discount to historical trading fundamentals. This would imply a level closer to 20x forward earnings, and would imply a share price of about $63. Coincidentally, this is where the yield would start to become above average as well. I like buying shares in a company when the fundamentals are fine and the market is discounting them for an unnecessary reason. Currently, I believe a premium is being assigned to the shares for the reasons outlined in the article. Should shares pullback to the $65 range, I would look to initiate a position.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in DNKN over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.