Dunkin’ Brands Group Inc (NASDAQ:DNKN) is a leading franchisor of restaurants that owns Dunkin’ Donuts and Baskin-Robbins brands. The stock has risen almost 40% this year compared to Nasdaq’s 5% which has led many investors to believe that the stock is overvalued at the moment and it might be time for correction. Fundamentally speaking, we believe the current market price is the valuation that the company deserves. Here are some of the reasons why we think the stock is rightly valued presently.
We have a $35 price estimate for Dunkin’ Brands, which is in line with the market price.
True Earning Potential Obfuscated by One-Time Expenses
One of the primary reasons why investors think that Dunkin’ Brands is overvalued is because of a high P/E ratio which currently hovers around 66-68. The company’s earnings in 2011 were negatively impacted by one-time expenses such as a loss on debt extinguishment, costs related to secondary offerings, impairment charges related to South Korea joint venture, and sponsor termination fee. Excluding these impacts, the P/E is much lower. In fact, the company’s forward P/E is around 24. Moreover, the money raised from the IPO last year was used to retire long-term debt, thanks to which it has a much better cash flow currently. Just to compare, it incurred interest expense of $16.7 million in Q1 2012 vs. $33.9 million in Q1 2011.
Healthy Comparable Sales Growth
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For 2011, the comparable sales growth of Dunkin’ Donuts outlets in the U.S. grew 2.8%. But, with the focus on breakfast paying off, the comps growth increased to 7.2% for the first quarter of 2012. Items added to the menu include Hillshire sausage sandwiches in the last quarter of 2011 and Angus steak & egg sandwich in the first quarter of 2012. Sales of K-cups at select Dunkin’ Donut outlets across the U.S. will also help increase comparable sales.
We expect the company to roll out more products in the future and estimate the average revenue per outlet to increase at a modest 4% annually. Note that you can drag the trend line in the chart above to arrive at your customized price estimate.
Franchising Model Ensures Low Capital Expenditure
Dunkin’ Brands plans to add around 550 to 600 outlets in 2012 globally. It plans to double the number of outlets for Dunkin’ Donuts U.S. to 15,000 in the next 20 years. There are still places where the restaurant chain has low or no presence. For example, Dunkin’ Donuts recently opened its first outlet in California. The state itself offers a lot of opportunity for expansion. Internationally, Dunkin’ Donuts opened its first outlet in India in May 2012 and now plans around 500 additions in the next 15 years. 
Baskin-Robbins’ international expansion is also on track with franchising deals in Vietnam, Mexico and the U.K. The ice cream chained opened its first outlet in Vietnam in late 2011 with plans to add another 50 in next few years. In the U.K., Baskin-Robbins plans to open 80 new outlets in three years beginning 2012. In Mexico, the company signed a new franchising contract with BRICE to open 25 new outlets in 2012 and at least 50 more outlets in next few years in the country.
Since most of Dunkin’ Brands restaurants are franchised, the capital requirements to open new restaurants are lower which ensures that expansion plans do not cause a strain on the company’s fiscal situation. The company incurred capital expenditure of $18.6 million in 2011. And for Q1 2012, the capital expenditure was around $4.3 million. Both the figures are quite low for a company with almost 17,000 outlets worldwide and aggressive plans of expansion.
The franchising nature of the business has another advantage. Dunkin’ Brands is shielded from any volatility in commodity prices. However, it is indirectly affected by a long-term increase in the costs of raw materials. Any aggressive menu price hikes can reduce the number of footfalls which can impact total sales, and note that Dunkin’ Brands revenues are a percentage of franchise sales.
Under-Performing Baskin’ Robbins Stores Closed in the U.S.
The number of Baskin-Robbins stores have witnessed a continual decline as the company has shut down under-performing outlets that haven’t performed up to expectations in the past few years. The move will help reduce cannibalization.
The strategy seems to be working as comparable sales for the Baskin-Robbins outlets in the U.S. witnessed positive growth of 0.5% for the first time since 2007. Sales in 2011 were also helped by the launch of cake bites, new holiday cards and the introduction of Baskin-Robbins gift cards.
Dunkin’ Brands has also stepped up advertising spend as part of its brand-building initiatives. For the first quarter of 2012, the comparable sales growth accelerated to 9.4% highlighting that the company’s efforts are paying dividends. Baskin-Robbins outlets in the U.S. had been struggling due to a shift in consumption of ice-cream at home and also by a sluggish domestic economy.
Note that we have used a 8% discount rate in our model.Notes: