Dunkin’ Brands Struggles After Another Disappointing Performance By International Segments in Q3

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

The International segments have let down Dunkin’ Brands’ (DNKN) for one more time. Despite solid revenue growth by the company in its Q3 earnings results released on October 22, the dreadful comparable sales growth by the company’s international segments led to an overall dull reaction by the investors. Soon after the result, DNKN stock fell from $42 to below $40, with only a slight recovery before the weekend. There were two major drivers that made this quarterly result a dull one for the investors: the continuous sluggishness in international business and slow restaurant development. Trefis has revised its price estimates for the company after the quarterly result, and estimates the company’s stock price at $44, which is roughly 5% above the current market price. Let’s discuss those factors in detail.

See full analysis for Dunkin’ Brands

What’s Troubling The International Business?

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In our prior article, we discussed how the company’s international segments were the key drivers in this quarterly result. (Read: Dunkin’ Brands Q3 earnings preview: All eyes on International segments) The domestic segments for both the brands, Dunkin’ Donuts and Baskin-Robbins, continued their strong momentum with 1.1% and 7.5% comparable store sales growth, respectively, in the third quarter. However, it was offset by flat comparable store sales growth of 0.8% by Dunkin’ Donuts International segment, coupled with a 2.4% decline in the comparable store sales of Baskin-Robbins International segment. This makes another quarter of sluggish performance by both the brands internationally. According to the company, the after-effects of the MERS virus outbreak in Korea are still negatively impacting the business for both the brands in that nation. On the other hand, Baskin-Robbins in Japan has been the worst performer for the company in this quarter. [1]

Furthermore, the MERS virus seems to be interfering with the company’s business in the fourth quarter as well. However, the company’s CEO, Nigel Travis promises to turn around the scenario in the international segments by the next quarter. In any case, with Japan and Korea underperforming for the company, the international segments do not seem to post solid comparable sales growth any time soon.

According to Trefis’ revised estimates, the net contribution of international segments to the company’s EBITDA profit will further decline to 10.8% in 2015. The net EBITDA contribution of the international segments has already declined from 17.9% in 2011 to 11.3% in 2014.

ebitda

Restaurant Growth Slows Down In Absolute Terms

In Q3, Dunkin’ Brands opened 90 net new restaurants worldwide, taking the total restaurant count to 19,185. The company opened net 68 new Dunkin’ Donuts stores, compared to 120 last year. This is due to the closings of some of the self-serve coffee stations located within the stores by Speedway. Dunkin’ Brands, in its Investors & Analyst Day presentation, mentioned that Speedway will be closing 100 self-serve coffee stations, which have been operated by third-party Dunkin’ Donuts franchisees. [2]

This decision is taken due to the fact that Speedway bought these locations on a condition that they didn’t want these coffee stations to be operated by any third-party. However, Speedway will continue to operate 500 Dunkin’ Donuts coffee stations, which are directly under their control. The company mentions that these 100 coffee stations generate much lower volume and revenues than the average, and represents only 10 basis points of Dunkin’ Donuts U.S. business. As a result, there might be no harm to the financial results with their closing. However, opening up new stores to meet the restaurant development guidance might cost them much more money.

Since the start of this year, 40 such stations have been closed, with 31 of the closings occurring in the third quarter. The company still has 60 more closings, and most probably it might happen in the next two quarters. The table below shows the net openings for each segment:

db rest

For Dunkin’ Donuts U.S., if we consider that there might be a similar number (140) of gross openings in the fourth quarter, and 30 of the rest of the 60 closings in Q4, we will have approximately 110 net openings, taking the total Dunkin’ Donuts openings for fiscal 2015 to roughly 330. The company has opened net 32 Dunkin’ Donuts stores internationally in the first nine months of 2015, and with a similar year-over-year growth rate, this number might jump to 80. The impact of change in the number of Dunkin’ Donuts stores on the company’s valuation can be analyzed below:

Baskin-Robbins U.S. has witnessed a tremendous slowdown in the net openings over the past few years, and this year it has witnessed a net 4 openings in the first nine months. Trefis estimates this number to reach 6 by the end of this year. On the other hand, the company has opened only 61 net Baskin-Robbins stores internationally in the first nine months of 2015, probably due to 16 net closings in Q3. Trefis forecasts the number of Baskin-Robbins international stores to increase by 120 in the fiscal 2015.

To summarize, we can expect the stock to remain in the current range till the performance of the international segments take a 180 degree turn. In the fourth quarter, investors will be looking for comparable sales of the international segments and the timing of the restaurant development pace.

Some of the takeaways from the Q3 earnings:

  • Net revenues increased 8.9% y-o-y to $209.8 million
  • Operating income increased roughly 8% y-o-y to $99.8 million, with an operating income margin of 47.5%, down 50 basis points y-o-y
  • Diluted EPS was $0.48, down 7.7% y-o-y
  • 90 net new restaurants were added in Q3, including 68 Dunkin’ Donuts U.S. stores

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Notes:
  1. Dunkin’ Brands, Q3 earnings call transcript []
  2. Dunkin’ Brands, Investor and Analyst Day 2015 []