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Coverage Initiation: Dunkin' Brands (DNKN)
Dunkin’ Brands (DNKN) is the holding company for the Dunkin’ Donuts and Baskin-Robbins chains. The founding of these two fast food restaurants dates back to the 1940s. For a time, they were owned by a subsidiary of Allied Domecq. After that company was acquired by Pernod Ricard, Dunkin’ Brands was sold to Bain Capital Partners, LLC, The Carlyle Group, and Thomas H. Lee Partners, L.P., so Pernod Ricard could focus on its core businesses.
In mid-2011, Bain, Carlyle, and Thomas H. Lee brought the company public via in initial public offering (IPO). As is often the case when investment funds bring a company public, the proceeds of the IPO went to the previous owners and not the company. Moreover, Bain, Carlyle, and Thomas H. Lee retained a material ownership stake in the company, creating something of an overhang on the stock because of the concern that the investment funds would sell their holdings once contractual holding periods end.
Dunkin’ Brands’ two concepts are household names in the United States, but both have material foreign operations. In fact, the company divides its business into four units: Dunkin’ Donuts U.S., Dunkin’ Donuts International, Baskin-Robbins U.S., and Baskin-Robbins International. As of March 2011, there were approximately 16, 250 Dunkin’ Brands locations in 57 countries.
The Dunkin’ Donuts concept (accounting for over 90% of revenues in 2010) had over 9,800 restaurants in 31 countries, with about 6,800 of those locations in the United States. Only 36 states and the District of Columbia host Dunkin’ Donuts locations, which suggests that there remains ample room for growth as the company expands the footprint of this concept. Historically known for its donuts and coffee, Dunkin’ Donuts has been expanding its offerings to include breakfast sandwiches and specialty drinks.
The Baskin-Robbins concept (accounting for less than 10% of revenues in 2010) had nearly 6,500 locations across 47 countries, with about 2,500 of those stores located in the United States. The U.S. locations are spread across forty-five states and the District of Columbia, suggesting that the company’s footprint can be expanded, but to a lesser degree than the Dunkin’ Donuts brand.
An aggressive franchise model is the backbone of the company’s operating structure, whereby almost all of its restaurants are operated by others. Although Dunkin’ Brands earns revenues in multiple ways, its primary source is a percentage payment from its franchisees’ sales. As of March 2011, Dunkin’ had almost 2,000 franchisees in the United States alone. The franchise model allows the parent company to focus its efforts on branding and product innovation, but takes a lot of control out of management’s hands, as its franchisees are operating the bulk of the customer facing operation. This arrangement can make it more difficult to maintain quality and service standards, and to see trends in the business.
The negative aspects noted, using such an aggressive franchise model allows for a great deal of leverage, since Dunkin’ Brands doesn’t have to come up with the capital needed to fund expansion. Expansion of both the Dunkin’ Donuts and Baskin-Robbins brands is a core growth initiative for the company, though international growth is the main focus for its ice cream operations.
Dunkin’ Brands is also looking to keep both concepts fresh and lively, with specific goals for its namesake segment of focusing on beverages and moving beyond its stronghold in the breakfast segment. The end purpose is to increase comparable-store sales (or comps in industry jargon), so that sales increase at units that have been open for at least one year.
In the often-fickle restaurant category, it is important to constantly innovate while not moving too far from one’s core. This can be a difficult balancing act and has proven problematic to many companies. With such a large store base, the above noted comps are an important metric to monitor. Weakness here could be a leading indicator of a flawed business model or undesirable product offerings. That said, fast-food restaurants are also subject to the impact of economic swings, so it is equally important to keep the environment in mind when reviewing comparable-store sales.
It is also important to note that, although Dunkin’ Brands is not directly affected by ingredient inflation, its franchisees are. As such, the royalty payments that Dunkin’ receives can be hurt by a reduction in sales as franchisees raise prices to cover the increase in input costs. Note, too, that supply shortages of coffee, an important product category for Dunkin’ Donuts, could have an outsized impact on the parent company.
Dunkin’ Brands controls two well-known restaurant nameplates with solid positions in niche food categories. There appears to be room for each concept to expand. Subscribers to The Value Line Investment Survey who are interested in the company and its ongoing performance should consult Value Line’s regular quarterly reports and keep an eye out for Supplemental reports for late breaking news.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.