Shares of Dunkin’ Brands (NASDAQ:DNKN) have outperformed the broader indices, surging more than 30% this year on the back of strong Q2 results and general optimism about the American economy. In addition to Dunkin’ Donuts, the company also operates the Baskin-Robbins brand. Dunkin’ Donuts’ American operations account for most of the profits. We estimate the division to contribute about 80% to the company’s total valuation.
Dunkin’ Donuts expansion strategy is pretty clear. It plans to double the number of stores in the U.S. to 15,000 in the next 20 years. The restaurant chain opened 291 stores last year and plans to add another 330 to 360 new stores in 2013. Expansion plans are great, but they can also backfire especially when a restaurant chain opens too many restaurants. As a result, the restaurant’s presence can be overwhelming to customers and could drive them away. Moreover, opening up too many stores can lead to cannibalization.
Most of Dunkin’s American stores are located in the eastern part of the country, particularly in the Northeast. Thus, the company has a significant opportunity to expand in the Western part of the U.S., especially in California where it has no presence currently. Recently the company has signed agreements with four franchisees to open 45 restaurants in California, beginning 2015. Furthermore, it signed another contract with Sizzling Donuts to open 43 new restaurants throughout Utah, Denver and Colorado within the next few years. 
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Light Capital Requirements
Another advantage of a brand like Dunkin’ Donuts is that its almost a 100% franchisee model. As a result, the company does not have to incur the expenses associated with opening a new store. In 2012, Dunkin’ Brands’ total capital expenditure was just $22 million. This also includes Baskin-Robbin’s capex. For a chain that has more than 7,500 stores in the U.S., an annual expenditure of $20 odd million is pretty insignificant. Thus, one thing that is certain is that the expansion drive will not put a dent on the company’s financials. As long as the management continues to execute the overall strategy effectively, the company will have no problem in opening stores quickly.
In addition to opening new stores, there is also an opportunity to grow the sales of its existing stores. Dunkin’ Donut is usually associated with the breakfast segment and therefore traffic dies down in the afternoon. In fact, only 40% of the sales are generated after 11am.  Management is working hard to change its image of merely a breakfast place, and new stores will feature sofas and televisions that it hopes will encourage diners to stay longer and order more in the afternoon.
Dunkin’ is also adding new sandwich and bakery products to boost their post-noon sales. It added 30 items to its menu including Breakfast Burritos, the Roast Beef Bakery Sandwich, Red Velvet Donuts, etc. in 2012. Similarly, some of the new items introduced this year are Turkey Sausage Breakfast Sandwich, Angus Steak and Egg Breakfast Sandwich, among others. We expect Dunkin’s same-store sales to rise at an annual pace of 3.5-4%, which is consistent with the historical data as well as the management’s own forecasts. A figure in this range looks feasible.
Restaurant chains such as McDonald’s or Burger King are present throughout the country and their store sales have slowed. It will be difficult for them to grow domestically from here on. On the other hand, an opportunity still exists for Dunkin’ Donuts to add a significant number of more stores and to boost the sales of its existing stores.
We have a $43 price estimate for Dunkin Brands, which is in line with the current market price.Notes:
- Restaurant Industry Enters Into Agreements for Brand Expansion and Reports Financial Results – Research Report on Noodles, Tim Hortons, Dunkin’ Brands, Arcos Dorados, and Bloomin’ Brands, August 14, 2013, marketwatch.com [↩]
- Dunkin’ Donuts Upgrades Stores to Be More Like Starbucks, June 13, 2013, bloomberg.com [↩]