Severe Weather Impacts Dunkin’ Brands’ Q1 Results

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DNKN: Dunkin' Brands Group logo
DNKN
Dunkin' Brands Group

Dunkin’ Brands (NASDAQ:DNKN) reported mixed results in the first fiscal quarter of 2014, as comparable store sales growth in the U.S. declined to 1.2 % compared to the 1.7% achieved during the same period last year. This was mainly due to the adverse weather conditions in North America. The decline in comparable store sales was more than offset by a significantly higher 6.2% increase in total revenues to $172 million, due to the increased sales of ice cream products as well as increased royalty income. Additionally, net income dropped 3.5% to $23 million, primarily due to a $13.7 million loss on debt extinguishment and refinancing transactions, as well as an increase in income tax expenses.

In the first quarter, the company initiated two unique strategies to drive revenue figures. One of the initiatives is the launch of online cake ordering  and enhanced cake designs by Baskin Robbins in the U.S. The company’s main strategic focus is to drive the cake sales by taking this initiative to a global level and to mitigate the impact of weather for any such situations in the future. The other initiative is the launch of Dunkin’ Donuts perks loyalty program, to attract more guests as well as to maintain the loyalty of existing customers. The company has set up a target of 2.5 million members in the program by the end of year 2014.

The company reaffirmed its performance guidance for the 2014 fiscal year and expects to generate a net income of $1.79 to $1.83 per share, an increase of 17% to 20% over the previous year figure. ((“DNKN 8-k”, First quarter SEC filing, April 2014))

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We have a $48.6 estimate for Dunkin’ Brands, which is approximately 6.5% above the current market price. In addition to the Dunkin’ Donuts brand, the company also runs the Baskin-Robbins brand.

See full analysis for Dunkin’ Brands

Slower Comparable Store Sales Growth

Same-store revenues of Dunkin’ Donuts’ stores in the U.S. increased by only 1.2%, much lower than the company’s yearly anticipated target of 3-4%. In 2013, the corresponding figure was 3.4%. Moreover, comparable store sales for Dunkin’ Donuts International declined compared to the positive growth seen  in the prior year period. Comparable sales or same-store sales is an important measure to gauge a restaurant’s performance since it only includes restaurants that are open for more than a year and excludes the effect of currency fluctuation.

The prominent factor leading to a decline in the traffic growth was the severely harsh weather in the North-eastern region of the U.S., where most of the DunkinDonuts’ restaurants are located. Moreover, freezing winter presented challenges for ice-cream industry. It is estimated that weather contributed approximately 200 basis points of negative impact in the first quarter. Additionally, major markets that saw little to no weather impact delivered very strong results. The increased average receipt ticket resulting from customers buying more items per transaction as well as premium-priced items were the major driving factors for whatever little growth that has been witnessed.

The introduction of new breakfast items in the menu as well as the improving weather may push the comparable store sales growth to around 3.5% for Q2.


Sustainable Margins

As Dunkin’ Donuts and Baskin-Robbins are almost entirely franchised brands, the company generates higher margins than non-franchised brands. Whenever the comparable store sales’ figure slows down, there is a concern that operating margins might also get dragged lower. Surprisingly, Dunkin’ Donuts U.S managed to improve operating margins by 190 basis points over the same period last year to reach 71.7 % in the first quarter. Similarly, Dunkin’ Donuts international witnessed an increase in its operating margin by 11.4 percentage points over the same period last year to reach 66.6%.

The company’s franchises saw an average EBITDA of around 12%, which is slightly up from the 2012 figure, as cost of goods sold have come down. Additionally, the first quarter saw an increase in the sales of high-margin products, like differentiated beverages and breakfast sandwiches. This drove profitability across the system, particularly in the western emerging markets.

Dunkin’ Brands Keen On Store Expansion

In the first quarter, Dunkin’ Brands added 69 net new Dunkin’ Donuts U.S. locations, which leaves them slightly slow in pace to achieve the estimated target of 380-410 stores for the fiscal year 2014. Most of the U.S stores are concentrated in the eastern part of the U.S and don’t have a big presence in the west part of the U.S. However, the plans to expand in western markets are on the charts. Adding new assets to the company will help them generate more revenues for the upcoming quarters.

The company also added 52 net new Baskin-Robbins outlets in international locations, 1 net new Baskin-Robbins outlet in the U.S., and 26 net closures for Dunkin’ Donuts International stores. Comparable store sales growth for Baskin Robbins International is largely driven by the performance of the stores in Japan,and similarly, for Dunkin’ Donuts International, the sales are highly affected by the company’s performance in Korea. The company has decided to target high GDP countries, mainly due to the brands’ tremendous reception in Germany in the first quarter.

By region, 30% of the  first quarter’s net development was in the core market, 32% in established markets, 22% in emerging markets, and 16% in western markets. Furthermore, Dunkin’ Donuts U.S. franchises remodeled 94 restaurants during the first quarter.

The food and beverage industry usually witnesses a slow pace in store expansions in the U.S. during the first trimester of the calender year. As is evident from the seasonality trend, the company gains momentum in later half of the year. So it is expected to see a total of around 150 Dunkin’ Donuts U.S restaurants set up by the end of Q2. The company expects to open its first traditional Dunkin’ Donuts restaurant in California by the end of the fourth fiscal quarter of 2014, ahead of its original expected date. The company is keen to expand, owing to the fact that the new store openings delivered 25% unlevered cash and cash returns to its franchises and this is the fourth year in a row that new stores achieved this target. In the long term, the company’s plan is to double the count of U.S, stores to 15,000 in the next 18-20 years.

The economic uncertainty, increased competition in breakfast as well as coffee categories and the legislative impact from issues such as minimum wage and healthcare are the major issues faced by quick service restaurants in this industry. Dunkin’ Brands, and every other major food chains for that matter, are looking forward to revamping their breakfast menu for the upcoming quarters. The company has around 9% share in the breakfast market, much behind the McDonalds Corp. (NYSE : MCD). Over the last couple of years, Dunkin’ Brands have gained reputation, due to their operational quality and consistent effort towards customer satisfaction.

The introduction of more drive-through locations, coupled with breakfast-menu optimization will aid the company to grab larger pie of the market share in the future and to widen their store revenues. The company’s newly launched initiatives and their expansion in developing countries will certainly widen the company’s operating margins in Q2.