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Is Dunkin' Donuts California Dreaming?

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Dunkin' Brands, (NASDAQ: DNKN  ) , the donut and coffee retailer that has grown by leaps and bounds has done so, surprisingly, without a presence in the largest state by population: California. Having been absent from California for more than a decade,  Dunkin' Brands started to sign up Dunkin' Donuts franchises in the Golden State last year.  That expansion came to tangible fruition earlier this month when The Embassy Suites San Diego Bay-Downtown had a grand opening for its onsite Dunkin' Donuts, the first store available to the public in the area. (There is a Dunkin' Donuts store at Camp Pendleton, a 45-minute drive from San Diego, but it's on a military base and civilians can't just stop by and get a doughnut there.) People waited for an hour and a half to get the doughnuts on opening day.  

In early March, Dunkin' Brands announced that it had agreements with 150 free-standing California stores to sell its doughnuts, with 45 slated to open later this year. The company has long-term plans to expand to more than 1,000 stores in the state.  What does all of this expansion activity in the most populous state in the U.S. mean for Dunkin' Donuts and its competitor, Krispy Kreme (NYSE: KKD  )  as investments?

Will California be sweet for Dunkin'?
Despite the breadth of its expansion into the state, Dunkin' Brands believes that it will be some time before California becomes a substantial financial factor for the company. On the company's February earnings call, CFO Paul Carbone said, "There's a tendency for all of us to jump to California when we discuss our long-term store expansion plans. It'll be many years before California and the West in total makes up a significant portion of our annual development."  

However, the California expansion comes as part of a larger aggressive expansion effort for Dunkin' Donuts stores. At the end of 2013, Dunkin' Donuts had 7,677 United States stores and a long-term goal of opening 15,000 stores nationwide. The parent company also sees international expansion opportunities, as it expects to open 300-400 net new Dunkin' Donuts and Baskin-Robbins stores abroad in 2014. (Dunkin' Brands is also the parent company of Baskin-Robbins.)  

Krispy Kreme is not keen
Dunkin' Brands may not feel that California is a significant financial factor for itself right now, but that doesn't mean its competitors feel the same way. In January, Krispy Kreme announced a plan to open 20 additional doughnut shops in Southern California. The new stores not only help Krispy Kreme build up its brand, they also help the company crowd out Dunkin' Donuts from more desirable store locations.  

Krispy Kreme has taken other steps to expand its product and brand awareness to counter Dunkin' Donuts, even outside of California. In February, Krispy Kreme announced an agreement with Green Mountain Coffee Roasters (NASDAQ: GMCR  ) to bring Krispy Kreme's signature coffee to K-Cup packs for the Keurig brewing system.  That same month, Krispy Kreme announced that it would introduce its ready-to-drink coffee varieties to Walmart  (NYSE: WMT  ) , expanding the reach of Krispy Kreme coffee products. 

Hmmm, digestible conclusion
So what does the California entry and expansion mean for Dunkin' Donuts? Well, for Dunkin' Donuts' competitor, Krispy Kreme, the entry of Dunkin' Donuts means that Krispy Kreme has had to ramp up its presence in the state and expand its brand through other channels.

For Dunkin' Brands, the California expansion comes as one of its more public new market expansion efforts, even though the company might not feel its financial significance immediately. For Dunkin' Brands investors, the optimistic growth of store openings means that Dunkin' Brands is a good buy, even if it is pricey with a P/E of 38.50 in comparison with the industry P/E of 23.60. Dunkin' Brands knows it needs to grow and with the population of California waiting for more of its doughnut stores to open, that seems to be a good place as any to start Dunkin'. 

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Johnny Chen

Johnny Chen is a very common name, with an uncommon background. Born overseas, raised near Metro Washington DC, educated (and accumulating too many degrees) in Virginia, Kentucky, Massachusetts, and California, Johnny Chen finds himself somewhat surprised that friends and colleagues come to him seeking investment advice. After many comments along the lines of "You really should write down what you said and publish it," he's decided to finally take that step.

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