We had a candid conversation with the top brass at Dunkin’ Brands yesterday. Given the timing of the call, and the fact that we have not been positive on the name, we took the call as a bullish sign in and of itself. The details were reassuring and several grey areas were clarified to our satisfaction.
Dunkin’ reaching out to us to schedule a call eight days before the company reports its 3Q earnings was surprising. If you have kept abreast of our writing on Dunkin’ over the past year, we have been critical of the company’s ability to execute on the long-term domestic growth projections that whipped up such excitement as the company came public. On top of that, we have been skeptical of actual same-store sales results meeting expectations in the back half of 2012. Same-store sales are not nearly as important for Dunkin’s profitability as unit growth, given the franchised nature of its business model, but comps do seem important from an investor sentiment standpoint. Below, we address these two aspects of the Dunkin’ story and update our thoughts.
We have consistently voiced our concern about what we perceived as a lack of disclosure, on management’s part, around the company’s new store pipeline. As was explained to us yesterday, in what we thought was a very transparent manner, the company’s future unit growth is partly stemming from existing franchisees. In 2012, 60% of new unit growth is accounted for by existing franchisees. Management explained to us the difficulty they have in calculating the backlog because of the undefined nature of existing franchisee commitments. Many franchisees are seeking to growth their businesses but, given the high level of concentration in existing markets, are looking west for that opportunity.
We have been concerned about 2H12 trends from a headline perspective as expectations are for a V-Bottom in two-year average trends through year end. We argued that even holding two-year average trends flat was likely overly bullish. We still believe that a same-store sales miss is possible but see the investments in technology and strong performance of recent food items at Dunkin’ as strong positives. We have seen with DPZ and SBUX that technology can have a significant impact on through-put, transactions, and both employee and customer-satisfaction.
The overall tone from management was very bullish. The entire senior management team was on the call to directly convey the message and extend an invitation to us to meet with them in person to dig deeper into store-level returns and the company’s growth outlook. We will be taking management up on the offer as soon as time permits.
For now, ahead of the 3Q print, we are pulling back on our bearish stance on Dunkin’. Concerns remain, but we believe that the positive aspects of this story are sufficient to warrant the current valuation.