Is Dunkin Donuts the Best Coffeehouse in Town?

During the last few years, the U.S. coffee market has grown more than ever. According to the National Coffee Association, more than 83% of adults in the U.S. drink coffee. As the coffee industry grows, so do the coffee giants like Starbucks (NASDAQ: SBUX  ) and Dunkin Brands' Group (NASDAQ: DNKN  ) . Let's have a look at Dunkin Brands in detail.

Quarterly earnings
In its third quarter, Dunkin Brands reported earnings per share of $0.37; this missed consensus estimates by $0.06. However, earnings grew 36% from the third quarter of last year. Revenue increased 8% to $186.3 million, topping estimates by $2.7 million.

Revenue at established U.S. stores rose 4.2% for Dunkin Donuts and 3.2% for Baskin Robbins. Revenue at established Dunkin Donuts outside the U.S. fell 1.4%, however, while it decreased by 0.7% at Baskin Robbins.

For the year, Dunkin expects to reach the low end of its earnings estimate -- $1.50 per share to $1.53 per share.

What's new at Dunkin Brands?
During this holiday season, Dunkin is offering its customers a wide range of new items and special discounts. Through Dec. 31, customers can enjoy any medium hot or iced latte at Dunkin Donuts for just $1.99. Dunkin's K-Cup packs for Keurig brewers can also bought for the special price of two boxes for just $19.99.The company has also released "The Dunkin Coffee Book," a set of 10 bundled coupons with each coupon valid for one "twenty-ounce hot coffee." According to Dunkin Donuts, this new coffee book is an ideal gift for someone who loves Dunkin's coffees and deserves special recognition.

In order to reap the benefits of a growing coffee industry, Dunkin is constantly expanding itself in the U.S. market. Recently, it opened two of its combination restaurants, one in Conway, AR and the other in Atlanta, GA. At these combination restaurants, Dunkin will offer a complete array of items from its premier brands – Dunkin Donuts and Baskin Robbins. The company has already signed two development agreements that will enable it to open four more Baskin-Robbins' shops in the greater Los Angeles area and twelve Dunkin Donuts' stores in Memphis, TN.

Financials
During the last five years, Dunkin Brands' EPS (ttm) has grown by almost 23%. In comparison to the last year, its earnings have jumped by a whopping 79% thanks to an operating margin of 39%. In the last year, Dunkin has yielded a return of more than 55% to its shareholders; this has the company outperforming the S&P 500 by 28% and DJIA by 33%. At a forward P/E (1yr) of 27, Dunkin looks like an expensive buy. However, this price is justified to some extent when looking at Dunkin Brands' growth in same-store sales. I say "to some extent" because Dunkin has a huge amount of debt in its capital structure. With a debt/equity ratio of 475, it's a massively leveraged company that is financing much of its growth through debt. This is further reiterated by the fact that it has a meager levered free cash flow per share of just $1.30.

Coffee industry outlook
The U.S. coffee industry has grown to become a $30 billion industry, the world's largest coffee market. Coffee consumption in the U.S. jumped by 5% in 2013. The coffee companies are enjoying healthy incomes not only due to strong demand from customers, but also from declining rates of coffee beans. As the coffee makers had plenty of coffee supplies this year, the Dow Jones-UBS Coffee ETF, which provides exposure to coffee futures, slipped by more than 40% in the past year.

Weaker currencies of exporting countries also contributed to low coffee prices. In 2013, the Brazilian real depreciated by more than 11% against the U.S. dollar. It was the same case with the Indian rupee, which declined around 10%. As these currencies weakened, the exporting countries were able to sell higher amounts at a slightly lower rate. This in turn lowered the price of coffee beans in the global market.

The global coffee supply will exceed its demand for a second straight year in 2014. The U.S. dollar is gaining strength in contrast to the exporting countries' currencies, something that will keep a further check on the global coffee prices.

Industry peers
Dunkin's biggest rival, Starbucks, has its eyes set on North America and India. In the U.S., it's building more drive-thrus and is introducing new lunch items like soups, sandwiches, and teas. The company has also already opened thirty stores in India and has further plans of expansion in the region.

In its latest quarter, Starbucks posted an EPS of $0.63 to beat Thomson Reuters' expectations by $0.03. In comparison to the previous year, revenue rose 13%, while same-store sales grew by 7%. At a forward P/E (1yr) of 25, Starbucks looks to be a great bargain at this stage. Furthermore, with a debt/equity of 29, it doesn't have high levels of debt in its capital structure. This is a testimony to the fact that the company is growing through its operating cash flow, making it the best buy in the coffee industry.

During the last few years, the McCafe coffee brand from McDonald's  (NYSE: MCD  ) has become a key revenue source for the company. Keeping this in mind, McDonald's and Kraft Foods Group have entered into a partnership that would enable them to test McCafe-branded packaged coffees at the U.S. retailers and grocery stores. The tests will include packages of ground coffee/whole bean and K-Cups for Keurig brewers.

In November, McDonald's witnessed a decline in its U.S. same-store sales by 0.8%. While Europe's comparable sales were up by 1.9%, they decreased 2.3% in the Asia/Pacific, Middle East, and Africa region (APMEA). As there's a lot of competition in the restaurant industry, McDonald's isn't expected to grow substantially in 2014 either. 

Conclusion
Dunkin's same-store sales reflects the fact that the company is constantly expanding in its biggest market – the United States. Moreover, discounts and special items for the holiday season will bring in more revenue for the company. The company is all set to ride the "coffee boom" in the U.S. as it has massive plans of expansion in the region. With the new franchise system, efficiency across its stores will reach new heights.

As coffee prices keep on dampening, Dunkin's margins are bound to go up in the next year as well. In short, Dunkin Brands looks an excellent buy at this stage. Keeping in mind that it's a highly leveraged company, however, it isn't the best investment in the coffee industry.

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