Dunkin’ Brands Q2 Earnings: Increased Competition Drags Down Comparable Sales

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Dunkin' Brands Group

Dunkin’ Brands (NASDAQ: DNKN) delivered disappointing results in its Q2 earnings report, as comparable store sales of the Dunkin’ Donuts U.S. segment increased just 1.8%. [1] The company was expecting the comparable sales to bounce back to the range of 3%-4%, as the impact of weather improved in the second quarter. However, the results were below expectation, as net revenues rose just 4.6% to $191 million. The increase in revenue was primarily driven from increased royalty income due to system wide sales growth.

At the beginning of second quarter, the company launched its initiative of online cake ordering for Baskin Robbins U.S., which delivered impressive results in the second quarter. Dunkin’ Brands is planning to take this to a global scale in the coming years. The company introduced new food and beverage items in its breakfast menu along with other innovative additions to the regular menu amid increased competition in the breakfast category and from the fast-casual segment. Eventually, Dunkin’ Donuts U.S. decided to expand its presence in the western markets, where the brand has enough scope for expansion.

We have a $48.31 estimate for Dunkin’ Brands, which is approximately 10.5% above the current market price. The company runs both the Dunkin’ Donuts and Baskin-Robbins chains.

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Disappointing Comparable Store Sales

Dunkin’ Donuts U.S. reported comparable store sales growth of 1.8%, which is below what the company anticipated. The company was expecting the comparable sales for this segment to bounce back to 3%-4% range due to almost negligible weather impact in the second quarter. However, sales did not pick up the pace due to tough competition in the breakfast market, non-seasonal rainy weather and other macroeconomic challenges.

  • Increased Competition In Breakfast Segment

Dunkin’ Brands is one of the major restaurant brands in the QSR industry fighting for the breakfast market share, as breakfast is currently the most competitive and popular segment. Other top competitors such as McDonald’s Corporation (NYSE: MCD), Starbucks (NASDAQ: SBUX) and Burger King (NYSE: BKW) are already far ahead in this category, with innovative beverage and food items on their menu. The company has around 9% share in the breakfast market, much behind McDonald’s. Although over the last couple of years, Dunkin’ Brands has gained reputation, due to its operational quality and consistent effort towards customer satisfaction.

However, new entrants do not directly impact Dunkin’s business but their entry increases the overall competition in the industry, reducing price manipulation in the market. The company’s breakfast menu performed below par in the first quarter due to less customer traffic in the breakfast hours driven by harsh weather. In the second quarter, the company introduced new limited offer products such as the Chicken Apple Sausage Breakfast Sandwich, differentiating it from other competitors. Furthermore, the low price of its breakfast menu led to an increase in customer traffic. In the second quarter, the company witnessed the highest afternoon guest count. Even though it was a positive sign for the company, the increased competition slowed down the comparable sales growth.

Whatever little growth was there in the comparable sales was partially due to increased guest traffic and somewhat due to new menu additions.

  • Weather Plays A Spoilsport: Drags Down Sales Initially In The Quarter

Dunkin’ Donuts U.S. faced harsh cold weather in the first quarter, which brought its comparable sales down. The company was anticipating the weather to improve in the second quarter. However, the second quarter started off with a non-seasonal cold and rainy weather when the restaurant industry was recovering from the damage caused by weather in previous quarter. However, the negative impact of the unpredictable weather on the quarter was below 100 basis points, as the company already took some counter measures for such situations.

  • Macroeconomic Pressure

The restaurant industry faced negative pressure from fluctuating economic situations in the U.S. Job growth in the first quarter was comparatively weak, with the impact being visible in the second quarter’s performance of the restaurant industry. [2] However, the economic situation has improved since the last two months, but its positive effect would be visible in the third quarter. Moreover, reduction in government programs and slow GDP growth added to the misery of rising costs. The overall mix of many other macroeconomic factors affected the restaurant industry as a whole.

Given all these factors and unimpressive second quarter’s performance, the company changed its guidance for comparable sales down to 2% to 3% for the fiscal year 2014.

Rising Commodity Prices Hurts Margins

The prices of commodities such as dairy products and sugar are showing an uptrend for quite a long time now. [3] On the other hand, the price of Arabica coffee beans has surged almost 100% from a level of 106 cents per pound to around 220 cents in mid April, due to tight supply as a result of a prolonged drought in Brazil, followed by recent floods. [4] The pressure from commodities is affecting every major Quick Service Restaurant (QSR) and other retail outlets.

However, Dunkin’ Brands, with only 36 company-owned points of distribution in the U.S. (as of March 29, 2014), are less affected by fluctuation in commodity costs than many other QSR operators. At the start of June, CEO of Dunkin’ Brands, Nigel Travis announced that the company is raising the coffee prices in its stores, though not by much. This move was primarily the result of the company’s competitors increasing their coffee prices. [5] J.M Smucker, which has licensing agreement with Dunkin’ Brands and Folgers, announced to raise the prices of the packaged coffee by 9%. Moreover, Nigel Travis also mentioned that franchise locations of Dunkin’ Donuts might raise the prices of the non-coffee products such as donuts and sandwiches. The price hike contributed slightly to the revenue growth as the move was completed in the last month of this quarter, but played a major role in maintaining operating margins. As a result, the company is not that affected by the rising coffee prices.

The Baskin Robbins business, however depends on dairy products, which have witnessed price rises over the past 3 months. This eventually raised the costs related to ice-cream production. This increased stress on the input costs dragged down margins by 70 basis points to 49.3% as compared to 50% last year.

Expansion Into Western Markets

The company was planning to expand in the western markets for a long time, as most of the stores are concentrated in the eastern part of the U.S and don’t have a big presence in western U.S. [6]The company announced the locations of its stores in California on June 10 and also mentioned its plans to open 54 more stores in Southern California in the coming years. [7]With nearly 11,000 Dunkin’ Donuts stores in 33 countries around the world, the company is keen to expand, owing to the fact that new store openings delivered 25% unlevered cash and cash returns to its franchises, and this is the fourth year in a row new stores achieved this target.

During the second quarter, the company opened 151 net new restaurants globally, with 75 Dunkin’ Donuts U.S. units. Out of all the net new development, 16% was in the west. Baskin Robbins International added 47 net new restaurants, primarily in the Middle East. The company continues to maintain its guidance of opening 380-410 net new Dunkin’ Donuts U.S. stores.

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Notes:
  1. Dunkin’ Brands: Q2 2014 earnings call transcript []
  2. Job growth remains weak []
  3. USDA report: World refined sugar price []
  4. Coffee futures, July contract, 2014 []
  5. Dunkin’ Brands to raise coffee prices []
  6. Expansion in the west provides opportunities for Dunkin’ Brands []
  7. Dunkin’ Donuts announces locations of its restaurants in California []