Dunkin’ Donuts Disses Starbucks

One key advantage Dunkin’ Donuts has over Starbucks and Krispy Kreme Doughnuts.

Feb 28, 2014 at 12:00PM

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Source: Dunkin' Brands Group

2013 was a great year for the most famous coffee and pastry trio: Dunkin' Brands Group (NASDAQ:DNKN), Starbucks (NASDAQ:SBUX), and Krispy Kreme Doughnuts (NYSE:KKD). All three of these companies, despite their already large sizes, continue to grow at an amazing pace. While they all have various growth plans, Dunkin' Donuts in particular may have the most potential for a very key reason.

The Starbucks problem
All three have ambitious expansion plans on the heels of fantastic results. Starbucks' last quarter saw revenue jump 12% to $4.2 billion, same-store sales and traffic pop 5% and 4% respectively, and earnings per share explode 25% to $0.71 (setting a new record.)

Starbucks is growing strong despite largely tapping out the U.S. market (at least temporarily.) Back in 2008, it started closing stores when too much cannibalization became a reality. Starbucks has since been able to grow aggressively internationally while once again growing its U.S. store base, though it's still off its peak.

These days where there seems like there is a Starbucks on every corner, the company is more careful about location choice. For Starbucks, potential cannibalization is still a problem in the U.S.

The Dunkin' Donuts advantage
In many areas where Dunkin' Donuts is located, most notably along the east coast, it can seem like there are two Dunkin' Donuts on every street corner instead of one Starbucks. Part of the reason for this is the smaller footprint and low cost for franchisees. This makes it easier for each location to find a profitable market.

Unlike Starbucks, however, Dunkin' Brands has vast areas in the U.S. alone that are currently untapped. For example, the chain is just starting to enter California for the first time. This is a state with over 38 million people that have had no local access to a Dunkin' Donuts before. You can be sure that it's not because donuts and coffee aren't popular there.

Dunkin' Donuts plans to, at a minimum, double its number of locations in the U.S. through this expansion. Will its stores be the same hit that they are back East?

Take a look at Colorado for a potential clue. When two Denver Dunkin' Donuts stores opened for the first time, the lines were literally out the door and across the parking lot. Not a big surprise. What would be surprising is if a new Starbucks in the U.S. resulted in a line that long. You probably couldn't even imagine anybody bothering, and he or she would just go elsewhere. That alone illustrates the potential of Dunkin' Donuts versus the more restricted opportunity of Starbucks in the U.S.

Anecdotally, obsession for Dunkin' Donuts coffee (and eats) remains at a feverish pace back East. As for the doughnuts, the West is famous for having mom-and-pop donut shops everywhere (and really awful doughnuts.)

Watch out for Krispy Kreme, though
Krispy Kreme ran into trouble over a decade ago by being overly aggressive with its expansion. The demand and profits weren't there, or at least didn't sustain themselves. Krispy Kreme was somewhat of a fad in a lot of places.

This time may be different. For the last few years, Krispy Kreme has been a bit more humble and focusing on its brand, its operations, and its offerings. It's starting to really pay off. Same-store sales were up a staggering 10% in the second quarter and another 3.7% with the third quarter.

Even that 3.7% was better than it looks since it was going up against another huge quarter comparison the prior year at 7%. More importantly, it was the 20th quarter in a row of positive same-store sales. Krispy Kreme CEO James Morgan plans to "unlock [the] brand's full potential."

Morgan added, "We are positioning ourselves for accelerated growth domestically with our new small factory store." It sounds like Krispy Kreme may be doing it the Dunkin' Donuts way.

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With the popularity of the brand at the store level continually growing, Krispy Kreme at some point creates some serious head-to-head competition down the road. For now, though, both chains have vast untapped territory with dense doughnut-eating and coffee-drinking populations. They could both do well at the same time.

Foolish final thoughts
Dunkin' Brand Group's advantage over Starbucks is the opportunity for vast growth without running into much cannibalization. At the same time, it has an advantage over Krispy Kreme in that it has a history of showing a given populous can support a relatively high ratio of restaurants as there are more Dunkin' Donuts than Starbucks in the markets that they currently share. Krispy Kreme could potentially prove to be in the same boat, but for now that is more speculative. Fools should give Dunkin' Brands Group a closer look. It may be like discovering Starbucks ten or more years ago.

The best stocks, like Dunkin' Donuts, have large potential untapped markets
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Nickey Friedman has no position in any stocks mentioned. The Motley Fool recommends Starbucks. The Motley Fool owns shares of 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 insights makes us better investors. The Motley Fool has a disclosure policy.

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