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DNKN did report a relatively strong quarter (with a few holes)  today, with the obvious exception being the implication from the secondary offering announcement that the equity sponsors want out ASAP.  This news was not very surprising to us given that the stock is the most expensive in the restaurant universe.

The line of questioning that the Street took with management is often insightful and on the DNKN call today, as with the EAT call last week, the dialogue was focused strongly on one area. For Dunkin, comparable store sales and K-Cups were the most touched upon topics.  We believe that the significance of comps and K-Cups is overemphasized by some; Dunkin’ Donuts is a franchise business model and the growth of its footprint is a far more meaningful driver of earnings.  With respect to unit growth, the quarter was a little disappointing.  To hit the mid-point of the target net unit opening range for the year of 220-230 new points of distribution, 107 net new openings are required in the fourth quarter.

Below are the top takeaways from the quarter:

  1. The company reiterated its goal to more-than-double Dunkin' Donuts' footprint in the USA to reach 15,000 locations over the next 20 years.  The company failed to disclose any details on its backlog of stores.
  2. In 3Q11, Dunkin' franchisees opened 57 net new locations; 70% of that development took place outside of the core markets.  But they are narrowing our projection of net new Dunkin' locations in the U.S. this year to 220 to 240 versus the previous wider forecast of 200 to 250. Its represents an acceleration from the net 206 restaurants in 2010, but a long way from reaching the 450 annual run rate needed to get the 15,000 target.
  3. On the call they said they have actively begun recruiting franchisees for markets in Texas, Colorado, New Mexico, Oklahoma and Nebraska, but do not expect new Dunkin' restaurants to open in any of these markets until early 2013.  On the call they said “we are focused on keeping our development pipeline build,” but fell short of revealing any numbers. 
  4. For the quarter, revenue growth of 13.3% far exceeded the system-wide sales growth of 8.3%.  According to the company they “offer our franchisees the opportunity to extend the term of their original franchisee agreement. And usually, when we do that, we can charge a fee associated with it.”
  5. It appears that the company booked a couple million in supply chain product designation/incentive fees this quarter, as well as $2M in refranchising gains, from where terminated stores are resold by DNKN at a profit.
  6. Dunkin International is not providing any real incremental growth to the overall organization.
  7. The management team does not really see SBUX’s move in to K-Cups as a competitive threat.

All in all, we do not see DNKN’s story as being compelling on the long side.  The equity sponsors are clearly not enthused and we contend that the Dunkin’ Donuts business model, as it currently operates in the US, is not viable west of the Mississippi and will not be for quite some time.  The hub-and-spoke model that the brand uses in existing markets would require a lot of capital to replicate in brand new markets.  For now, the donuts and other baked foods cooked at commissaries in existing markets will be flown into new markets frozen.  Whether or not that passes muster with consumers, the run-rate of new store openings needs to escalate rapidly in order for the guidance of a footprint of 15,000 domestic locations within 20 years is to be reached.  The lack of disclosure concerning the backlog is the biggest red flag from the quarter.


Howard Penney

Managing Director

Rory Green