The largest market in the United States for Starbucks (NASDAQ:SBUX) is California where it has over 2,000 locations. Dunkin' Brands Group (NASDAQ:DNKN) is in the process of expanding its footprint out West. Bulls argue that Dunkin' Donuts is popular in the East so this will also be true in the West. Bears argue that consumers have different preferences out West and the Starbucks culture is there to stay. Few seem to have noticed a solid clue that came from Krispy Kreme Doughnuts (NYSE:KKD).
America runs on coffee
No doubt you've heard the slogan "America runs on Dunkin'." This obviously refers to its coffee rather than its donuts. Dunkin' Donuts, like Starbucks, relies on coffee for the majority of its sales with America's addiction, desire, and dependence on high-quality and flavorful caffeinated drinks.
Starbucks illustrated an example of this during a presentation in June of last year. Troy Alstead, CFO of Starbucks, noted that in California between Los Angeles and Bakersfield, there is a whole lot of nothing. There are farms, desert, and long stretches of empty road there, and not much else. Smack in the middle of nowhere there is a Starbucks with a drive-thru. It just so happens that this location is one of the top five stores by volume in the entire U.S. for Starbucks. It seems like Californians "need" their coffee and the location is an oasis for passers-by.
What about Dunkin' Donuts and Krispy Kreme Doughnuts?
Bears will acknowledge that Dunkin' Donuts does well in the Northeast where much of the chain is concentrated. It's popular and it has a legacy, and that extends all the way down to Florida. Some will point out that many people from up north move down there and help keep the brand strong. California, though, is completely new territory, and the chain is basically starting from scratch there. Most Californians haven't even seen a Dunkin' Donuts location before, let alone tried one.
Enter Krispy Kreme Doughnuts
Krispy Kreme Doughnuts has long been considered an immensely popular chain in the Northeast just like Dunkin' Donuts. However, unlike Dunkin' Donuts, Krispy Kreme Doughnuts has been in California for years. It's not nearly as successful as Starbucks there, but there are some interesting hints to consider.
First, Krispy Kreme Doughnuts started out with oversized large factory-style restaurants out West. The model was never like that of Starbucks, which has a location seemingly on every corner. Second, Krispy Kreme Doughnuts has finally figured out that the "small-factory design" is the way to go for many of its new locations and this is similar to the model for most Dunkin' Donuts shops.
Back in January, Krispy Kreme Doughnuts announced that one of its franchisees will triple its store count in Southern California. This franchisee, which is Krispy Kreme Doughnuts' third largest, had rather dormant growth for years before this announcement even though it has been a franchisee since 1998.
Krispy Kreme Doughnuts is expanding -- so what?
During Krispy Kreme Doughnuts' conference call in March of this year, there was something interesting revealed during the Q&A session that many people seemed to have missed. Alton Stump of Longbow Research asked if the reason for the expansion into California was due to "very good trends." Otherwise, as his questioning implied, it could have just been a move based on pure speculation or hope.
Douglas Muir, Treasurer and CFO of Krispy Kreme Doughnuts, responded, "Comps are stellar on the West Coast, yes."
Stellar is interesting. Krispy Kreme Doughnuts has arguably been seeing "stellar" same-store sales increases across its entire chain. Last year, company-owned stores saw their sales jump 6.7% and it was the fifth year and 21st quarter in a row of positive same-store sales growth. Domestic franchisees saw an even better result at 9.9%.
Since the California locations were "stellar" in comparison to the rest, this means that the franchisees likely saw growth significantly north of 9.9% in California. Domestic systemwide sales for Starbucks grew by 8% in fiscal 2013. Starbucks is working from a bigger base to start, however.
Though Krispy Kreme Doughnuts' growing success in California doesn't automatically mean that Dunkin' Donuts will also be a success, it is a data point in Dunkin' Donuts' favor and proves that Californians are willing to enjoy products from a Starbucks competitor. It's hard to imagine a domestic region in the United States where Krispy Kreme Doughnuts is a smash hit but Dunkin' Donuts is a failure.
The reality is that all three can probably thrive together just about anywhere as they appeal to different tastes and, if you're like me, to people who like a little variety. The bottom line is that Dunkin' Donuts will face plenty of competition in California but it has a vast opportunity for system sales and profits to expand anyway and this will probably come at the expense of Starbucks to some extent.
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.