Dunkin' rally justified as stock looks fairly valued
The company believes it will be able to post comparable sales growth of about 3.5% in the long run.
For a restaurant chain, top-line growth typically occurs through two ways: generating more sales at its existing restaurants and adding new restaurants. In this article, we'll investigate what the company is doing to address those issues.
America Runs On Dunkin
Dunkin' Donuts' expansion strategy is pretty clear – double the number of stores in the U.S. to 15,000 in the next 20 years. The Western part of the country, in states such as Texas, represent huge untapped markets -- so the potential to expand is certainly there.
Moreover, the last couple of years has seen the number of stores rising within the U.S. (243 and 291 new stores were opened in the U.S. in 2011 and 2012, respectively). This year Dunkin' will add 330 to 360 new stores in the country. With its expansion plans on track, there is a certain amount of assurance that its store count will keep on rising.
Dunkin' believes it will be able to post comparable sales growth of around 3.5% in the long run. The big question is whether the chain can achieve this figure. This is one aspect of growth which has a higher degree of uncertainty. This is the breakdown of the 350 basis points that the company is targeting:
Pricing: 50 basis points
Customer traffic: about 150 basis points
Move towards a more premium mix: around 150 basis points
The annual pricing gains of 50 basis points shouldn't be too much of a problem. This is lower than the long term U.S. historical inflation. Moreover, menu price increases are implemented by all restaurant chains -- so Dunkin' will not be alone in doing this.
Now, coming to the remaining two issues. There is an opportunity for the restaurant chain to attract more footfalls during the afternoon, since Dunkin' Donuts is typically associated with the breakfast segment. Adding new sandwich and bakery products should boost their post-noon sales. At the same time, it will also help change its image of a restaurant chain serving just doughnuts and coffee.
It added 30 items to its menu including Breakfast Burritos, the Roast Beef Bakery Sandwich, Red Velvet Donuts, etc. Similarly, some of the new items to watch out for this year are Turkey Sausage Breakfast Sandwich, Angus Steak and Egg Breakfast Sandwich, among others. Extending its timings is also another way to generate incremental sales. Right now, about 2,000 Dunkin' stores in the U.S. remain open for 24 hours.
Maybe the split between the number of footfalls and the mix could vary but overall, annual comps of 3.5% don't look unreasonable. If this were to rise to about 4.5%, we could have 10% upside to the current valuation, assuming all other things remain the same. Similarly, if the comps fall to about 2.5%, we could see a 10% lower valuation.
We have a $38 price estimate for Dunkin Brands, which is in line with the current market price.
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The stock rises 9% after the company reveals strong second-quarter results.
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