We understand why Dunkin’ Brands is selling its stock, but why are they selling into such a promising growth story? Announcing the decision late on a Friday was also curious. Along with the announcements of Outback Steakhouse potentially going public again, it is clear that Bain Capital is looking to reduce its exposure to the restaurant sector while the going is good. If Dunkin’ is the best growth story in town, why are they selling?
DNKN’s stock has been trading well recently, along with the market, in the run up to the dividend announcement and the continuation of bullish underlying fundamentals in the restaurant industry. Our view on the longer-term TAIL still stands. Opportunities for the company to grow west of the Mississippi are far less abundant than the bulls believe.
The evidence for our view is as follows: announced new unit openings are lagging actual openings, which is leading to a decline in the backlog of potential new units being opened. Until we are proven wrong by greater disclosure from Dunkin’, we will continue to be bearish on the company’s growth prospects per the announcements of new contracted openings by the company.
Compounding this uncertainty is the aggressive strategy being pursued by MCD and, less concerning for DNKN, WEN in the North East breakfast day part. McDonald’s is a tough competitor and its new breakfast initiative in the North East, including cheese Danishes, muffins, and banana bread, is a signal of intent to take share from Dunkin’ Donuts in its most important region.
Much of the optimism around the growth story recently was brought about by the recently signed procurement and distribution agreement with a Dunkin’ Donuts franchisee-owned cooperative. Having spoke with our contacts in the Dunkin’ Donuts franchisee community, we believe that the hype may not be matched by reality as time passes.
The contract should benefit the system overall, but we are waiting for action; year-to-date, only nine contracted new restaurant openings have been announced. The rollout of the supply chain benefits will happen over a three year period. From our conversations with franchisees it also seems that DNKN will not receive supply chain rebates or incentives going forward; rather, those rebates will now go to the franchisee-owned co-op. The franchise savings from the new arrangement will be greatest for franchisees in new markets. “All regions will benefit” but clearly the 200-300 basis points of projected savings for the biggest beneficiaries is not representative of the total system.
On an annual basis, DNKN EBITDA currently benefits from approximately $8-12M in rebates from suppliers. In order to compensate for that going away over the next three years, it is imperative that growth in new franchisee units accelerates sufficiently in order to compensate for that decline.
Most of the research notes that we see on Dunkin’ tend to focus heavily on same-store sales as a key metric for the health of the company. We would agree that comparable restaurant sales growth is an important metric but it is not the most important metric for driving incremental value for shareholders. Since Dunkin’ is a franchised business, its EPS growth is far more leveraged to new unit openings than to comparable restaurant sales. Call us skeptics but we are not encouraged by the company’s lack of disclosure on this issue. Unless we see a dramatic ramp up in announcements of contracted new unit openings, we will retain our current stance.
Recent same-store sales trends remain consistent versus last quarter (with a slight benefit from favorable weather trends). We continue to hear that the majority of the improvement in same-store sales is coming from average check and not traffic although the company is also less-than-forthcoming with details on this topic. The question remains whether check is up due to success of K-Cup sales, increased food mix, or pricing. Items like the steak and egg breakfast sandwich and other new lunch items released in 2011 are helping check but we believe that traffic growth is minimal to slightly negative.