Dunkin’ Donuts, owned by Dunkin Brands (NASDAQ:DNKN), has more than 7,000 restaurant outlets in the U.S. The restaurant chain contributes 77% to the overall stock price, according to our estimates. Besides Dunkin’ Donuts, the company also owns Baskin-Robbins. Here we discuss a couple of trends that drive the restaurant chain and how their performances will affect the profitability of the company. 
1) Comparable Restaurant Sales
Dunkin’ Donuts’ comparable sales growth (or comp sales) stood at 2.8% in 2011. The figure accelerated to 7.2% in the first quarter of 2012 helped by the introduction of new menu items such as Hillshire sausage sandwich in the fourth quarter of 2011 and Angus steak & egg sandwich at the start of 2012. These offerings also help the customers view Dunkin’ as a restaurant chain offering more than just coffee or doughnuts. Further, sale of Dunkin’ Donuts K-cups, compatible with Keurig single cup brewers, is also boosting the sales at its restaurants. Comp sales slowed down to 4% in Q2, which was generally in-line with the company’s expectations. We expect the figure to stay in a similar range in the long term.
Since Dunkin’ Donuts has traditionally focused on menu items associated with breakfast, it plans to generate higher sales during afternoon by offering items such as bakery sandwiches and tuna and chicken salad sandwiches. At the end of 2011, only 12% of the total franchise sales were generated during the afternoon slot (i.e. 2 to 5 p.m). Note that all of Dunkin’ Donuts restaurants are franchised. That means Dunkin’ Donuts derives its income by fees and royalties earned through its franchisees, which are a function of franchise sales.
2) Restaurant Expansion
Dunkin’ Donuts plans to double the number of restaurants in the U.S. to 15,000 in the next 20 years. In 2012, the restaurant chain will add 260 to 280 restaurants in the U.S. The company still has no presence in California, where it is working on building infrastructural requirements needed to support its operations. The western part of the U.S., in general, represents a significant growth opportunity for Dunkin’ since its penetration is only 1 store for one million people (as of 2011 end). There are other states too, like Texas, where the restaurant chain has a limited presence, so there is plenty of opportunity to expand.
Since the restaurants are franchised, only a fraction of the total capital expenditure is incurred by Dunkin’. In 2011, for example, the restaurant chain added 243 new outlets in the U.S. while capital expenditure for the total company (which includes Baskin-Robbins as well) stood at $19 million. So, we don’t expect its expansion drive to put a strain on its balance sheet.
A word of caution though. The greater the presence, the more difficult it gets to sustain high comp sales since the new restaurants start cannibalizing the sales of existing ones. Starbucks faced a similar situation back in 2008 which forced it to shut some of its stores in the U.S.
We have a $34 price estimate for Dunkin Brands, which is about 15% above the current market price.Notes: