Shares of Dunkin Brands Inc (NASDAQ:DNKN) were giving investors an upset stomach earlier this month, falling 12% on October 1 to near 52-week lows after the coffee-and-donut chain scaled back its forecast for the year.
Management said that comparable sales slowed to 1.1% in September from 2% the year before, and said that a major franchisee, the convenience-store chain Speedway, would shutter 100 outlets through next year. The flatlining comparable sales and the store closures may mark the end of a rapid growth phase for the upstart fast food chain, especially at a time when McDonald's Corp. (NYSE:MCD) is rolling out all-day breakfast across the country.
Memories of Krispy Kreme
Dunkin' Donuts has accelerated new store openings in the U.S. every year since 2009 and is now adding about 400 new locations annually, with over 8,000 stores nationwide.
Dunkin' executives have long insisted that there is ample room in the market for expansion, having penetrated the northeastern U.S. deeply. In 2012, the company had 1 store for every 9,560 people in its core markets in New York and New England, as opposed to just 1 store for every 1 million people in the West. Management believes it has a significant opportunity for growth based on its market penetration rate in the Northeast, but if it were to achieve that rate across the country that would mean about 33,000 Dunkin' Donuts in the U.S., a level no restaurant chain has reached.
Meanwhile, saturation is a real risk for rapidly expanding restaurant companies. Through a low-priced franchising model, Subway became the largest restaurant chain by store count in the country, but sales are now falling at the sandwich behemoth, down 3.3% last year. Consumer tastes have shifted, and franchisees are disgruntled as the resale price for a franchise has plummeted.
Closer to home for Dunkin' is the experience of Krispy Kreme (NYSE:KKD). In 2004, shares of the donut chain cratered as a combination of the low-carb diet craze and brand overextension killed profits, and it was forced to close stores and retrench. In 2004, it had 374 domestic company-owned stores. By 2014, after a sustained growth period it had less than 300 domestic stores, most of which were franchised. Even Starbucks was forced to close 600 stores in the run-up to the recession after its own misguided wave of expansion.
The McDonald's threat
Of all the fast food chains, Dunkin' Donuts may be unique for serving all-day breakfast, but it's just lost that advantage with McDonald's decision to do the same. The Golden Arches is now offering a pared-down breakfast menu 24 hours a day, including favorites like the Egg McMuffin.
According to a recent survey, McDonald's is the favorite choice for "breakfastarians," Americans who like to eat breakfast twice a day, and with nearly double the number of locations of Dunkin' Donuts nationwide, it certainly has the footprint to make an impact. With its McCafe line, McDonald's has also increased its bet on the breakfast crowd. Dunkin' management is prepared for the increased competition, but has not yet announced any menu items or strategic moves to combat McDonald's move.
Going forward, Dunkin' Donuts still plans to open as many as 440 new domestic stores this year, a sign that Speedway's decision to close 100 outlets isn't a threat to its overall expansion. But comparable sales of just 1% seems to be a warning sign, especially with traffic declining 0.7% in the quarter, and this is in an environment where sales at bars and restaurants nationwide are up 8.5% thanks to low gas prices and a stronger economy.
Even near a 52-week-low, shares are trading at a relatively lofty P/E of 25. With stores closing, same-stores growth slowing, and McDonald's challenging it on all-day breakfast, Dunkin' shares could have further to fall.
Jeremy Bowman has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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