Why Dunkin' Brands Group May Not Stand a Chance Against Starbucks

Despite ambitious growth plans and a promising Westward expansion, Dunkin Brands won't catch Starbucks without a major operations overhaul.

Tamara Walsh
Tamara Walsh
Oct 13, 2015 at 6:00PM
Consumer Goods

Dunkin' Brands Group (NASDAQ: DNKN) and Starbucks (NASDAQ: SBUX) operate similar businesses. Both command hoards of loyal coffee drinkers, both have key partnerships with Keurig Green Mountain, and both boast ambitious growth plans. However, there is a reason that Starbucks' stock is up more than 47% year-to-date, while Dunkin' Brands stock has lost nearly 5% of its value over the same period.

Source: Dunkin' Brands Group.

The donut and coffee chain announced this month that it would close around 100 under performing stores amid both sales and traffic declines at its U.S. locations. Meanwhile, Starbucks welcomed 431 new net store openings in its latest quarter, and its same-store sales jumped 7% in the period. It's in this spirit that we will take a closer look at why Dunkin Brands needs to make some operational changes if it hopes to stand a chance against java giant Starbucks and other coffee and breakfast rivals going forward.

In need of better cost controls
Let's be clear about something ... The 100 Dunkin' locations set to close over the next year are, in fact, small-format Dunkin' Donuts kiosk shops located within Speedway convenience stores. This is important because the company says that the franchised closures will enable Dunkin' Brands to open full service stores in some of these markets going forward. The company is on pace to open as many as 440 new Dunkin' Donuts shops in the U.S. this year. However, Dunkin' Brands should tackle some key operating issues before it presses forward with its domestic expansion plans.

For starters, Dunkin' says its results will suffer due to nationwide increases in minimum wages. New York State joined other U.S. states earlier this year saying it would increase the minimum wage to $15 from around $8.75 per hour for fast-food employees in the region.

Dunkin' Brands said many of its franchisees have already begun raising menu prices to help offset the rising costs of wages. However, this could ultimately hurt traffic at its stores because unlike Starbucks whose customers are willing to pay a premium for their products, Dunkin' Donuts customers are lower income and therefore more susceptible to price inflation.

Source: Dunkin' Brands Group.

Perhaps Dunkin' should revamp its menu to include some higher margin options like those offered at Starbucks. This may be a better plan than raising prices on all existing menu items, though both strategies risk alienating repeat customers. As it stands, a classic egg and cheese breakfast sandwich at Dunkin' Donuts costs around $2.49 whereas a comparable option at Starbucks will run you around $3.45. That said, Dunkin' Brands still enjoys some of the richest margins in the business because unlike Starbucks, nearly 100% of Dunkin' Donuts stores are owned and operated by franchisees.

Dunkin' may also want to take a page out of Starbucks mobile playbook. After all, a loyalty program such as My Starbucks Rewards makes it faster and easier for consumers to check out at Starbucks locations -- thereby boosting traffic and customer satisfaction. Not to mention, mobile app ordering would also help franchisees cut down on costs because it is cheaper and carries less fees for franchisees versus credit and debit card payments.

An inferior mobile ecosystem
Dunkin' launched its mobile app and "DD Perks Program" last year. However, it still has some catching up to do with Starbucks whose member rewards program has been going strong since 2009. Starbucks now boasts more than 10 million loyalty members. Moreover, the coffee giant has aggressively expanded its My Starbucks Rewards program recently to include new services such as Mobile Order & Pay and strategic partnerships to fuel membership growth.

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Source: Starbucks.

One such incentive is its recent deal with ride-sharing service Lyft. As part of the deal, all Lyft drivers across 65 U.S. cities are now eligible to become My Starbucks Rewards gold level members. This gives Starbucks an advantage over Dunkin' since existing My Starbucks Reward members are more likely to get their morning cup of Joe from Starbucks and thus become repeat customers.

Additionally, Lyft passengers now have a way to digitally bestow a Starbucks eGift card upon their drivers through the Lyft mobile app. This is revolutionary because unlike Dunkin's loyalty program that is only available through the Dunkin' app, Starbucks' rewards program is now integrated into other third-party apps, thereby making it more widely available to consumers.

Starbucks worked out a similar deal with Spotify and The New York Times recently as well. With so many ways to earn Starbucks Rewards, Dunkin's fledgling mobile initiatives and loyalty program likely don't stand a chance against the specialty coffee retailer.

A stronger growth stock through and through
As you can see, Dunkin' Brands needs better cost controls in place at existing locations and a stronger mobile and digital loyalty ecosystem if it hopes to truly compete with Starbucks. These things don't happen over night.

To be clear, I'm not saying Dunkin' Brands is a terrible stock. In fact, it actually looks slightly more attractive than Starbucks stock based on valuation today. Dunkin's stock currently boasts a price-to-earnings growth rate of 1.85 and a P/E of 24 -- both of which are better than the broader industry averages today. Meanwhile, shares of Starbucks appear fairly valued trading around 1.89 times earnings growth, despite the stock's P/E of 34 being above the industry median price-to-earnings of just 26.

With shares of Dunkin Brands now trading near the stock's 52-week low, many investors may view this as an attractive entry point. However, from a fundamental perspective Starbucks is a much stronger growth story that will continue to reward investors for many more years to come. Looking ahead, analysts expect Dunkin' to achieve revenue growth between 6% and 8% compared to low double-digit revenue growth for Starbucks.