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Not for the average shareholder…

If you are a DNKN shareholder you are happy because the stock is working.

I have my reservations about what “reality” means for the company.  I have yet to see evidence that the stated long-term growth rate can be achieved.  As I have said in the past, sweetened up deals for franchisees in new markets and a clear preference for less disclosure as opposed to more on the part of management is not encouraging.

Looking at the comparable-store sales trend, the two-year average is declining.  High single-digit same-store sales growth is impressive but the change on the margin is not, as it stands, pointing higher.  Despite the lack of importance of comps for a franchised business, it is likely that a continuation of this trend would spur concerns more broadly about the company’s ability to grow.  If comps decline to 5% and bulls capitulate on that, but the pipeline and returns on new units are shown to be healthy, I will be the first to react by advising clients to take advantage of the selling.  As before, I will remain skeptical of this story until I see the data to convince me otherwise. 

The DNKN senior executives continue to be all glowing about “future demand” while the largest shareholders can’t sell their stock fast enough.  Remember, the senior executives at DNKN are employed at the company because the largest shareholders put them there. Knowing this it should come as no surprise that the company will use additional leverage to take out selective shareholders of their stock.   

Yesterday, at an investor conference the company’s CFO Neil Moses had this to say – “So it should come as no surprise that we’re sitting at about 4.2 times debt-to-EBITDA today. You're right; we've talked about being very comfortable in the 5, maybe even 5.5-times range. We're very fortunate because I talked about having dual wide-space opportunities in terms of growth, but there's also quite a bit of stability to our business. If you look back over the last 12 years and you say, "What are the worst comp stores – Dunkin' Donuts U.S. comp stores sales performance you've recorded in 12 years?" It's minus 1%. So, our business is very stable during the economic downturn where some of our competitors experienced mid-single-digit negative comps. We were basically flat.

And so, I think that business model allows us to support a lot of debt. If we levered it up back to the 5 times range, the most likely use of cash, I think, would be a share repurchase program we've already announced, I think a pretty aggressive dividend program earlier this year. When we talk about share repurchase, it probably wouldn't be public float because we're about 70% publicly owned today and 30% owned by our private equity owners. So, it might take the form of a share repurchase from our private equity owners. That would be the most likely use of cash, at least, in the short term.”

I know this is common practice and is good news for the stock in the short run; it’s a red flag for me.  With the dividend news out of the way and now the share repurchase strategy; we are back to fundamentals driving the story.  On this metric the trends are slowing.  

Howard Penney

Managing Director

Rory Green