Does America Still Run on Dunkin'?

The doughnut maker reported slower than expected U.S. growth and has lowered its projections for the year.

Jul 26, 2014 at 7:06AM

Were he still with us, Fred the Baker, the Dunkin' Brands (NASDAQ:DNKN) character famous for waking up before dawn because it was "time to make the doughnuts," might have found that he can sleep in a bit later. The chain is forecasting slower U.S. sales growth than previously expected for the rest of the year.

In its most recent quarterly report, released Thursday, the purveyor of doughnuts, coffee, and other breakfast and lunch foods -- as well as Baskin-Robbins ice cream -- said sales in the U.S. were weaker than expected, growing only 1.8% for the period. 

The company blamed the economy and weather, without touching on the fact that it might be affected by a growing consumer trend toward healthier -- or at least seemingly healthier -- options. That trend has also hurt rival McDonald's.

"We believe this was largely the result of macroeconomic challenges facing consumers, as evidenced across the retail and the QSR industries, along with an unseasonably cold, rainy start to the spring season," said Dunkin' Brands CEO Nigel Travis. "Dunkin' Donuts U.S. transaction growth was encouraging and comparable-store sales gradually improved throughout the quarter, with June average weekly sales reaching the highest volume on record.  We remain confident  in our ability to drive long-term growth through our product and marketing innovation, including our mobile and loyalty programs."

That optimism did not stop Dunkin' Brands from revising its profit outlook for the year. The company now expects Dunkin' Donuts U.S. comparable-store sales growth of 2%-3%, down from the previously expected 3%-4%. 

Krispy Kreme Doughnuts similarly lowered its profit and sales expectations for the year. 

There is a lot of competition
There was a time not that long ago when Dunkin' and McDonald's had the quick-serve breakfast market largely to themselves. Now the two morning-meal titans must fend off challenges from Starbucks as well as upstarts like Yum! Brands' Taco Bell, which has been attempting to win a share of the breakfast market. 

The doughnut chain has been working for years to increase its volume later in the day -- as of 2013, Dunkin' made about 40% of its sales after 11 a.m., according to Bloomberg Businessweek. Starbucks, the same article reported, generated 50% of its sales after 11 a.m. Dunkin' has tried everything from offering more lunch and dinner options, like sandwiches and pizza variants, to investing heavily to make its stores are comfortable places to hang out.

Those efforts have likely helped the company grow its sales -- just not as fast as expected. Dunkin' is also likely being hurt by McDonald's own efforts to spruce up its coffee offerings with its McCafe brand. 

Dunkin' has tried to answer consumers' demand for healthier products by offering egg whites as an option for its breakfast sandwiches, along with chicken and turkey sausage, but it's difficult for a company with the word "Donuts" in its name to push itself as a healthy choice. No matter the menu options the company creates, it's about brand perception -- Dunkin' won't be perceived as a healthy brand any more than Kentucky Fried Chicken was when it started offering grilled chicken and calling itself KFC. 

There are some positive signs
There are worse problems to have than slower-than-expected sales growth, and Dunkin' did improve sales in some categories while bringing in more customers. 

Iced coffee, frozen drinks, espresso beverages, breakfast sandwiches -- along with add-ons, including hash browns -- and even some limited-edition doughnuts were all cited by the company as strong performers in the earnings release. Another winner was the Chicken Apple Sausage Breakfast Sandwich, which shows that while the company may never be perceived as a healthy brand, it can make inroads in winning over customers looking to make better choices.

Can Dunkin' fix it?
Dunkin' has invested heavily in improving the look and feel of many of its stores, and it has had some success in finding a product mix that appeals during more parts of the day. Its strategy may not be working as fast or as well as it hoped, but it's not failing.

Changing how customers see your brand takes more than some new furniture and a chicken sandwich. Dunkin' must continue to try new things, rolling out limited-time offerings, and figuring out what works. Whether it's non-pork sausages, promotional doughnuts, or something untried -- like savory doughnuts or bubble tea -- the chain seems to be heading down the right path by continuing to evolve beyond its coffee-and-doughnuts origins.

It's a hit-or-miss strategy, but as the small hits pile up, traffic trends become more predictable. Dunkin' has for years offered apple pie pastries on a seasonal basis, which suggests the limited-time offering does well. Once the chain finds enough of those items, along with more permanent menu items with afternoon and evening appeal, it should be able to turn the corner.

Dunkin' will likely never be seen as a dinner and lunch brand first, nor will it be viewed as a hub for healthy eating, but the company can grow in those areas and pick up the pace of improvement in its same-store sales.

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Daniel Kline has no position in any stocks mentioned. He is from the Boston area where Dunkin' Donuts is plentiful. The Motley Fool recommends McDonald's and 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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