A Quick Service Restaurant Heading in Two Different Directions

At one time, Dunkin' Brands (NASDAQ: DNKN  ) was best known for its doughnuts, or ... donuts. After all, most people refer to this sweet and caffeine-product packed establishment as Dunkin' Donuts, not Dunkin' Brands. It's called Dunkin' Brands because it includes Baskin-Robbins, a hard-serve ice cream treat that many look forward to on occasion.

While Dunkin' Brands still offers tasty doughnuts and refreshing ice cream, it's now best known for its coffee. Therefore, let's see how it stacks up against other quick-service coffee providers.

A top-tier brand
Regardless of what you read from this point forward, it should be noted that Dunkin' Donuts and Baskin-Robbins are top-tier brand names. Therefore, their potential is always going to be high, especially in strong consumer-spending environments. 

Decelerating comps growth (for the most part)
The good news is that Dunkin' Brands is still seeing comps growth, which can't be said for all quick-service restaurants. The bad news is that comps growth has decelerated in two of four of its segments:

 

Q2 2012

Q2 2013

Dunkin' Donuts U.S.

4%

4%

Dunkin' Donuts International

3.5%

(1.7%)

Baskin-Robbins U.S.

4.6%

1.6%

Baskin' Robbins International

1.5%

2.6%

Domestically, Dunkin' Donuts has maintained its comps-growth pace thanks to higher average ticket and improved traffic. For higher average ticket, increased demand for premium-priced cold beverages and sandwiches played a big role. The traffic-boost stems from product innovation and effective marketing.

Staying on the domestic front, Baskin-Robbins saw a big decline in comps growth. Put simply, more people like to eat ice cream at home these days. The decline in growth was partially offset by limited-time offers for take-home ice cream as well as flavors of the month and cake sales.

Moving overseas, Dunkin' Donuts didn't provide a reason for its comps decline. For Baskin-Robbins, we at least know that demand is strong in South Korea.

If you only looked at total revenue for the quarter, which by the way moved 5.9% higher to $10.1 million year-over-year, then you would only see a positive trend. But this number includes 151 new net openings, which helped drive the number. 

The overall takeaway here is that Dunkin' Donuts is performing on par domestically, and sub-par internationally; and that Baskin-Robbins is performing well internationally, but not as well domestically. Perhaps a different coffee provider offers a better investment opportunity.

Dunkin' Brands vs. peers
When you think of coffee, Starbucks (NASDAQ: SBUX  ) should immediately come to mind. Starbucks might not be growing as fast as it did in the past, but it's still growing. And with consistent product innovations added to its menu, it seems as though the growth will never stop. Starbucks also has growth potential in emerging markets. However, one of the biggest reasons many investors prefer Starbucks over Dunkin' Brands is pricing power.

Starbucks has the ability to charge premium prices for its specialty coffees, which aids the company's top line. Another reason some investors prefer Starbucks over Dunkin' Brands is atmosphere. The cozy and pleasant atmosphere at Starbucks shouldn't be overlooked. It's much more appealing than the atmosphere at most Dunkin' Donuts, and it's what keeps customers at the location, often ordering more drinks and snacks as they sit and work or socialize.

Then there's the polar opposite of Starbucks when it comes to coffee, which is McDonald's (NYSE: MCD  ) . This doesn't refer to quality, but price. At McDonald's, you can order many different coffees from the McCafe Menu, including Premium Roast Coffee, McCafe Mocha, and Premium Roast Iced Coffee. McDonald's coffee is freshly brewed every 30 minutes, and it's made from 100% Arabica beans. Plus, you won't pay an arm and a leg. This has led many consumers to McDonald's instead of Starbucks.

Let's not forget about convenience. Currently, only Dunkin' Donuts and McDonald's offer coffee via drive-through. However, Starbucks is on the move, and it has the potential to steal market share because of this move. On the other hand, with a value consumer ruling the day, Starbucks isn't the most resilient of the bunch. Thanks to its sheer size, McDonald's is the most resilient.

Dunkin' Brands and Starbucks also don't hold up to McDonald's on a fundamental basis. Consider the table below. 

 

Dunkin' Brands

Starbucks

McDonald's

Trailing P/E

36

34

17

Net margin

18.95%

11.06%

19.85%

ROE

22.97%

28.74%

37.79%

Dividend yield

1.80%

1.20%

3.20%

Short position

8.20%

1.10%

0.90%

Conclusion
As an investment, Dunkin' Brands is caught somewhere between Starbucks and McDonald's. If you believe the consumer will rebound, then Starbucks is likely to offer the best investment opportunity. If you feel as though the economy is in disarray, and the consumer will continue to weaken, then you want a quality defensive name like McDonald's.

As far as Dunkin' Brands is concerned, it's seeing increased growth in some areas and decelerating growth in others, making it a difficult story to decipher. Dunkin' Brands has performed well since its IPO, and it has upside potential, but since capital preservation is always the number-one priority, I would favor McDonald's. 

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