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Should You Buy Dunkin's Hot IPO?

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Yesterday, the IPO of Dunkin' Brands (Nasdaq: DNKN  ) flew out of the gate, rising 47% to $27.85 per share. Fool Bryan White had a great rundown on the company before its debut. Dunkin' has been one of 2011's more anticipated IPOs, even though it offers decidedly old-economy fare compared to other hot IPOs this year.

But the market is now pricing Dunkin' shares at 17 times EBITDA, which looks dear compared to competing donut-frier Tim Hortons (NYSE: THI  ) . I asked three of our analysts whether it was time to buy the name behind Dunkin' Donuts and Baskin-Robbins.

Chris Baines, analyst
Yes, Dunkin' Brands has a lot of debt. Is that a bad thing? Heck no.

If there any business could benefit from lots of debt, it's Dunkin'. Its nearly 100% franchised business is remarkably stable and recession-proof, since coffee and donuts are practically mandatory spending for many Americans. Dunkin's high interest expense simply means that changes in revenue will have a magnified impact on the bottom line. For a slow and steady grower like Dunkin', that's more of an asset than a liability. (Literally it's an accounting liability, but you catch my drift.)

When you combine that high debt load with the high operating leverage of a franchiser, like McDonald's (NYSE: MCD  ) , you can see that tons of fun await investors if Dunkin' achieves only modest sales growth. (The company plans to double its number of stores over the next 20 years.) That's why Wall Street has priced Dunkin' so loftily. The donut-meister outpaced McDonald's revenue growth last year.

But the price, mind you, really isn't that expensive. Compared to Starbucks (Nasdaq: SBUX  ) -- whose non-franchised business model and growth opportunities are less compelling -- Dunkin' trades at around 36.7 times last year's pro forma earnings, against Starbucks' roughly 30.9. Considering that slow revenue growth could make a serious dent in Dunkin's P/E, it's still a good deal for long-term owners who can wait out post-IPO volatility.

Rick Munarriz, analyst
I'm sorry. I can't view this through jelly-filled glasses: Dunkin' is no $3 billion company. We're talking about anemic top-line growth, marginal profitability, and a concept that has delivered negative store-level comps in two of the past three years. You have to go all the way back to 2006 to find the last time that comps even kept pace with historical inflation growth! 

It's ironic that during the same week in which McDonald's agreed to make its Happy Meals healthier, and Whole Foods Market (Nasdaq: WFM  ) launched a charitable foundation to fend off childhood obesity, we're celebrating the debut of a company that sells fatty doughnuts and ice cream.

I'm more worried about waste lines than waistlines, though. Dunkin' wants investors to buy into the merits of a popular franchise model, but making money here won't be as easy as sitting back and collecting passive royalties. Where are the economies of scale in this much-touted model , when Dunkin's sporting net margins of less than 5%?

I'll stick to McDonald's, thank you very much. At least there, I'm treated to consistent double-digit net margins. The world's largest burger chain also has tested its recession-resistant mettle, and it's not simply busy during the morning breakfast rush.

Anders Bylund, analyst
We've seen plenty of this year's IPOs debuting way above the official offering price. On their respective first days of trading, Pandora (NYSE: P  ) jumped as high as 62% above the $16 starting price, and LinkedIn (Nasdaq: LNKD  ) briefly commanded an IPO premium of 170%. So Dunkin's first-day jump is nothing special.

But those other high-tech IPOs didn't stay strong -- in a matter of days, LinkedIn shares had fallen by double-digit percentages, and Pandora gave up its offering premium right away. Even if both stocks have since recovered, I don't think that either one should have.

Both LinkedIn and Pandora are burning cash every quarter, and they're still struggling to figure out profitable business models. Admittedly, I'm encouraged by increasingly varied Pandora ads, now including traditional marketing stalwarts like Toyota's Lexus division. By stark contrast, Dunkin' comes in with a long and generally profitable operating history, with strong and rising cash flows.

In short, I think that Dunkin' deserves a premium, whereas many other instant market darlings don't. In fact, running Dunkin's numbers through our Inside Value newsletter's DCF calculator (click here to take the tool for a spin with a free trial) with extremely modest growth assumptions of 5% a year tells me that this stock is worth nearly $37 per share. In short, you still have a margin of safety here.

Foolish bottom line
We have two yeas and one nay from our analysts. If you need to get more fill on the Dunkin' IPO, click here to listen to our radio show.  What do you think? Is it time to buy Dunkin' Brands? Let us know in the comments section below.

Jim Royal, Ph.D., does not own shares of any company mentioned here. The Motley Fool owns shares of Whole Foods Market and Starbucks. Motley Fool newsletter services have recommended buying shares of Tim Hortons, Whole Foods Market, McDonald's, and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insightsmakes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (10) | Recommend This Article (24)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 28, 2011, at 11:12 AM, mikecart1 wrote:

    IMO Dunkin serves better food than McDonalds and the other fast food chains. They serve better coffee too. However, I am not your typical American fatty and rarely go to either places. Dunkin Donuts is a good fast food chain in a flooded fast food market. Selling coffee, pastries, breakfast sandwiches might have been revolutionary 20 years ago. But let's face it. McDonald's owns this sector like Bill Gates owns Windows.

  • Report this Comment On July 28, 2011, at 12:35 PM, wolfhounds wrote:

    Not to mention that few retail investors read the prospectus in where the sellers converted their L shares at the IPO price of $19. At the current price, not only are the shares diluted from day one, but the sellers helped themselves to an instant 30% or so capital gain by keeping the offering price low.

    When the deck is stacked against the retail buyer at the IPO, it's buyer beware.

  • Report this Comment On July 28, 2011, at 12:43 PM, onacone wrote:

    Great article! What was left out of the article was the other company of Dunkin Brands. Dunkin Brands has two companies Dunkin Donuts and Baskin-Robbins. Baskin-Robbins has been around for with more than 62 years it has 6,000 retail shops in 35 countries, it’s now the world’s largest chain of ice cream specialty shops. Baskin-Robbins is also 100% franchised business. Baskin-Robbins also brings value to Dunkin Brands.

  • Report this Comment On July 28, 2011, at 2:21 PM, chadhenage13 wrote:

    A few things:

    1. Comparing Dunkin Donuts to McDonalds doesn't make a lot of sense. As anyone can tell you Dunkin Donuts main business is coffee. Having family from New England let me tell you, the question of "do you want anything from Dunkin Donuts?" has nothing to do with donuts.

    2. To wolfhounds comment, this happens nearly all the time with IPO's. Unless you are an institutional investor don't expect to see the IPO price.

    3. How many people know that there are only about 70 Dunkin Donuts west of the Mississippi? Considering the company is expecting to double it's restaurant base I'm thinking quite a few people out west are getting a D&D.

    Last I would suggest this is a simple industry, with loyal customers and is simple to understand, sounds like a winner to me.

  • Report this Comment On July 28, 2011, at 4:16 PM, wolfhounds wrote:

    All the above may be quite true about the company. My wife always goes to either Dunkin or McD for coffee.

    But to MMenage I say that the usual play before an IPO is to pass through debt and pay a dividend to the sellers. There is no stock dilution there, just debt to worry about. As the article points out, the debt seems manageable. What occurred here is legitimate, but not well understood by general investors. The company states it is issuing x shares with the usual over allotment. That's fine. You can make a calculated guess on what kind of return to expect based on future growth. However, if you're not aware that substantially more stock will be issued because of a conversion coinciding with the IPO, then your assumptions are off because of the larger share count. It will show up in EPS immediately.

  • Report this Comment On July 29, 2011, at 6:07 AM, JaneBond wrote:

    Sounds like a lot of hype to me.

  • Report this Comment On July 29, 2011, at 7:16 AM, energysystems wrote:

    On the surface, DNKN looks appealing. But once I got into the numbers, I stepped away. 5% margin(much lower than any competitor; and even though not a competitor, MCD's margin is over 20%). Enormous debt(makes expansion plans a more difficult to achieve). Slow growth and oversaturation in it's current locations. I am appalled that there margins are 5%. How? They sell coffee(beans+water) and donuts(dough+oil). If you can't make a decent margin out of that, there is a reason there debt load is so high. Had I not been so thorough in looking into their numbers, I was going to buy in. I'm glad I didn't.

  • Report this Comment On July 29, 2011, at 9:59 AM, susan400 wrote:

    makes it sound like it can't go down

  • Report this Comment On August 05, 2011, at 12:52 PM, Truth2Power wrote:

    I am starting to think that one of the best stock strategies would be to buy shares of an IPO at the opening bell on the day of issue, hold them until the stock seems to peak, and then sell. Then wait weeks, months, or even years to buy back in. Especially for hot IPOs, one could make a TON of money.

    As for DNKN, after looking at everything, I'd buy in either 1) when the share price drops after the IPO--possibly with the rest of the market, if the dire predictions come to pass--to the low-to-mid 20s, where it seems to me there is assured value, even taking debt and low margins into account OR 2) after I've seen a couple of quarterly statements indicating that the long-term plan is going according to, well, plan.

    I also agree that Dunkin's big business is their coffee more so than their donuts. MHenage, I had no idea DDs were so sparse out west, but I'd still like to see some proof that management is able to effectively roll out their new franchises before taking a gamble at this price.

  • Report this Comment On September 18, 2011, at 5:49 PM, motledfool wrote:


    It was refreshing to find your bottom-line analysis. Thank you for posting it.

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