Dunkin’ Brands’ IPO took place over a year ago amidst what we called a coffee bubble in valuations within the category. When Dunkin’ came public, valuations for the Dunkin peer group had gained an average of 56% over the previous twelve months. Additionally, we estimate that the aggregated market capitalizations of GMCR and (the US division of) SBUX in July 2011 were almost equal to the entire United States coffee market’s annual revenues. The table below shows the swings in valuations of the stocks of some QSR names over the past couple of years.
Dunkin’ Brands stands as one of the most expensive QSR names at 13.5x EV/EBITDA NTM (Chipotle is the only company with a higher valuation). The bull case hinges upon a belief that the company’s franchised business model and the Dunkin’ Donuts “white space” growth opportunity within the U.S. justifies the premium valuation. We do not agree.
If we were conspiracy theorists, which we are not, we would likely frame the Dunkin’ Brands story something like this:
- The insiders could not get out fast enough, with their “swan song” leveraging up the company to buy the remaining stake this month
- Of the 14 members of the DNKN board, 5 are representatives of the selling stockholders
- The insider selling occurred as SSS at Dunkin’ Donuts accelerated from 2% to 7% on massive new product introductions and the introduction of K-CUPS. Both events will not reoccur in over the next 12 months making comparisons very challenging
- The selling to investors of the “white space” growth opportunity was made possible by the new franchise distribution agreement. In theory, this should help accelerate franchise unit opening. Franchise units opening have been slowing for two quarters (U.S. Gross openings were flat year-over-year in 2Q12, while net openings of U.S. Dunkin’ Donuts units came to 19 versus 54 expected by the Street)
- In trying to put their best foot forward to generate investment banking fees, sell-side expectations for what DNKN can do operationally are stretched. For example, for nearly every company we track, consensus expectations have 1 and 2 year SSS trends slowing over the next two quarters except DNKN and DNKN is lapping its most difficult SSS compares in over 5 years
- As you can see from the chart below, consensus expectations are for the company to reaccelerate unit opening after missing for the past two quarters
- Valuation compression is likely in the coming months
How long is your list of list of consumer companies that is going to see a V-Bottom in two-year average sales trends in the back half of 2012?
We would imagine that list is very short and are almost certain that Dunkin’ is not on it. However, consensus is modeling an acceleration in two-year average trends even after the 2Q12 miss. After the 2Q unit openings miss the bulls have shifted from “growth” to “comps” and will have nowhere to go if the comp number comes in light for Dunkin’ Donuts. Even maintaining flat two-year average trends is likely overly-bullish but that scenario, illustrated by the chart below, shows comps missing consensus by 154 and 233 basis points in 3Q and 4Q, respectively.
We don’t think comps are overly material for Dunkin’ Brands; it is a franchised business whose future earnings growth is primarily predicated on unit growth. Nevertheless, the decelerating trend in same-store sales numbers over the remainder of the year and in to 2013 will not help generate incremental franchisee demand for the Dunkin’ Donuts brand.
Howard Penney
Managing Director
Rory Green
Analyst
