Dunkin' Brands (NASDAQ:DNKN) is looking to enter the California market much quicker than many had expected. By year-end, Dunkin' plans to have five new Dunkin' Donuts stores open. Dunkin' is hoping to get it right this time after exiting the Golden State in 2002 due to low sales. Dunkin' Brands Group is counting on a California resurgence to fuel its expansion plans.
However, it's not going to be easy for Dunkin'. McDonald's (NYSE:MCD) and Starbucks (NASDAQ:SBUX) are formidable competitors and have a strong presence with many of their prime locations in California. This is a big advantage for McDonald's and Starbucks considering how expensive California real estate is. Is a Dunkin' expansion into California big enough to move the needle for Dunkin' Brands Group and mount a challenge to McDonald's and Starbucks in the Golden State?
A second try in the Golden State
There are currently only three Dunkin' Donuts locations in California. But they are what the company considers nontraditional locations since they are not stand-alone stores. There's a Dunkin' Donuts at Camp Pendleton, the Embassy Suites hotel in San Diego, and at a travel center in Barstow, Calif. The last traditional Dunkin' Donuts store in Sacramento, Calif. closed in August 2002.
Chances are Dunkin' Brands executives have been doing a lot of studying of what went wrong when Dunkin' Donuts first tried to expand in California. The good news this time around is that Dunkin' Brands Group is under new management.
Furthermore, the California locations will be franchised, so Dunkin' Brands is also relying on its franchise partners to help make expansion work this time around. Franchise opportunities were made available last year, and so far Dunkin' Brands has deals in place for more than 200 shops in the Golden State. The first five stores will open in Downey, Calif., Long Beach, Calif., Modesto, Calif., Santa Monica, Calif., and Whittier, Calif. Construction is expected to start this month.
More good news
Dunkin' Donuts already has a fan base in California, with many East Coast transplants living in the state. Previously, the only way to get Dunkin' Donuts coffee outside of one of the three nontraditional locations was at the local grocery store. Dunkin' Donuts bagged coffee is available in grocery stores, and California is the top-selling state for Dunkin' Donuts bagged coffee.
It is good news that there's strong demand for Dunkin' Donuts coffee. Dunkin' Brands Group is also familiar with California since it has Baskin-Robbins ice cream shops already in the state. The company will also benefit since the franchisees of the Santa Monica, Calif. and Modesto, Calif. locations are already existing Dunkin' Brands Group franchise partners.
Now, the bad news
The hardest part for Dunkin' will be that the chain is entering Starbucks' and McDonald's prime territory. Starbucks has more than 2,500 stores in California, which makes it the company's largest market and comprises more than 12% of its total store count.
Already, McDonald's and Starbucks have many of the prime locations. In California, many locations require a drive-thru since most Californians are commuting by car. This will add to Dunkin's real estate costs since location sites will have to be bigger.
How are McDonald's and Starbucks going to defend their turf?
All three companies are tough competitors, especially when it comes to breakfast. McDonald's is determined to hold its 31% market share in the breakfast category by emphasizing its Egg McMuffin and McCafes. The other thing McDonald's is looking to emphasize is that the company actually cracks its own eggs in the kitchen and then cooks the food. Each McDonald's restaurant has a full kitchen. This is something that neither Starbucks nor Dunkin' Donuts can claim.
Starbucks isn't so much looking to defend its turf, but it is instead looking for more turf. Starbucks has no intention of slowing down, and that's bad news for Dunkin' Brands and McDonald's. Starbucks has several growth drivers; these include its Teavana Tea, La Boulange baked goods, a partnership with Keurig Green Mountain, a mobile-payment app, gift cards, and eventually a Happy Hour where Starbucks sells beer and wine.
So far, the results speak for themselves, as Starbucks posted same-store sales growth of 6% in its most recent quarter. Dunkin' Brands saw its U.S. same-store sales rise only 1.2% in the first quarter, and McDonald's just reported that U.S. same-store sales fell 1% for the month of May.
Foolish final thoughts
The key to Dunkin' Brands, besides being more than just coffee and donuts, is expansion. California is an untapped market for the company with lots of potential. The good news is that it's a market open for expansion in the U.S., the richest market in the world.
For investors, shares of Dunkin' Brands look attractive, as the company has an operating margin of 39%. McDonald's has an operating margin of 30%, and Starbucks' operating margin is only 15%. If Dunkin' Donuts is successful in California, it could be a game changer for Dunkin' Brands and could take shares higher.
Mark Yagalla has no position in any stocks mentioned. 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.