What's Wrong With Dunkin' Brands?

Dunkin' Brands had solid momentum since its IPO, but all of that seems to have been reversed this year. Here's why.

Jul 28, 2014 at 5:23PM

Dunkin' Brands  (NASDAQ:DNKN) is a formidable business. The coffee and doughnut empire boasts more than 17,000 points of distribution in nearly 60 countries across the globe. This includes 10,000 Dunkin' Donuts locations and 7,000 Baskin-Robbins stores.

And yet, its stock price performance this year signals trouble in the works. Shares of Dunkin' Brands are down 11% year to date. Its stock suffered a 4% decline after it reported disappointing second-quarter sales last week.

Its performance has been much worse than others in its category. For example, fellow coffee giant Starbucks (NASDAQ:SBUX) has seen its shares rise this year, and it generated record earnings per share for its fiscal third quarter.

While Dunkin' Brands keeps opening new locations, the performance of its existing locations leaves much to be desired.

Momentum halted
Dunkin' Brands has had a great run since its initial public offering back in 2011. Since closing at $27 per share on its first day of trading three years ago, the stock had gone on a nearly uninterrupted run to more than $50 per share.

But the stock has trended lower over the past several months, and there are indeed reasons to be concerned that maybe there are too many Dunkin' Donuts out there.

On the surface, there didn't seem to be anything alarming about Dunkin's earnings report. Total sales grew 4%, and diluted earnings per share increased 13% year over year. This is satisfactory enough and not in and of itself reason to worry.

But digging beneath the surface reveals a disturbing trend. It seems Dunkin' Brands is leveling off in developed markets like the United States. Same-store sales, which measure sales at locations open at least one year, are slowing down. Same-store sales increased just 1% last quarter, and management acknowledged its concerns about this.

Chief Executive Officer Nigel Travis stated that comparable-store sales growth didn't meet expectations, which management attributed to the weak consumer.

This is a recurring trend in the quick-service restaurant industry. Perhaps the biggest QSR of them all, McDonald's (NYSE:MCD), released its own poor earnings report that showed same-restaurant sales declined 1.5% in the United States in its second quarter. Total sales inched up just 1%, and diluted earnings per share increased 1% due primarily to billions spent on share buybacks.

Nevertheless, Dunkin' Brands management is entirely confident it will meet its ambitious long-term growth forecasts, which will be driven by future store openings. In all, Dunkin' Brands expects to open as many as 410 new restaurants this year.

But the ongoing performance of its existing restaurants remains a concern. The company reduced its 2014 same-store sales target for the year but still expects as much as 3% comparable growth in the United States.

Volatility could continue
Dunkin' Brands may see further volatility since it's pretty aggressively priced. Shares of Dunkin' exchange hands for 31 times trailing earnings and 20 times forward earnings-per-share estimates. The lofty valuation could put new investors at risk if the company keeps falling short of estimates each quarter.

This is one distinct advantage working in McDonald's favor. It trades for just 15 times forward earnings, an important discount that provides a margin of safety. Another margin of safety is McDonald's 3.3% dividend yield, which is well above Dunkin' Brands' roughly 2% yield.

To be sure, Starbucks enjoys a sky-high valuation, but it's got growth on its side. Starbucks regularly meets analyst estimates and has a better growth story to keep investor sentiment high. To that end, its same-restaurant sales grew 7% in the United States and drove record third-quarter revenue.

The U.S. quick-service food industry is looking more saturated by the day. Companies are seeing growth flatline in the United States due to constant and fierce competition as well as continued stress facing the consumer.

When you put all of this together, it's reasonable to doubt Dunkin's ability to meet its ambitious expectations this year.

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Bob Ciura owns shares of McDonald's. 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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