Dunkin’ Brands (NASDAQ:DNKN) has had a terrific year so far. Shares of the company have jumped more than 45% in 2013, which has led many investors to believe that the stock is overvalued and it might be time for correction. Fundamentally speaking, we believe the current market price is the valuation that the company deserves. Here are some of the reasons why we think the stock is not overvalued.
We have a $48 price estimate for Dunkin Brands, which is in line with the current market price
1) Strong Brand Name Coupled With Low Capital Requirements
- Dunkin’s Top Line Suffers In Q3 As It Witnesses A Decline In Comps Due To Refranchising
- Dunkin’ Brands’ Q3 FY’16 Earnings Preview: Weakness In Comps To Continue
- Ready To Drink Coffee : The Next Growth Driver For Dunkin’ Brands?
- Dunkin’ Vs. Starbucks: Who Is More Leveraged?
- Dunkin’ Brand’s Five-Pronged Strategy Paves The Way For Future Growth
- Breakfast Sandwiches, Coffee Sales Lead Dunkin’ To Profitability In Q2’16, Even As The International Segments Suffer
Dunkin’ is one of the iconic brands in the food industry and enjoys a strong brand recognition not just in the U.S. but globally. This is particularly useful to the company, given its plan to expand into new markets. Dunkin’ Donuts currently has more than 7,500 stores in the U.S. but plans to double that figure to 15,000 within the next 18-20 years. 
Most of the restaurant additions will occur in the Western part of the country, where it has a relatively low presence. Currently, most of Dunkin’s American stores are located in the Eastern part of the country, particularly in the Northeast. An expansion drive which involves opening stores in untapped markets should generally be better than one which involves adding stores in the saturated markets. Given the rate at which the company is adding stores at the moment, this target looks achievable.
Another advantage of Dunkin’ is that it follows the franchise model. Therefore, most of the expenses related to opening new restaurants are borne by the franchisees. Even though the company added 650 stores globally in 2012, it incurred a capital expense of mere $22.4 million.  This also gives the company the flexibility to accelerate or slow down the rate of store addition, depending on market conditions. Moreover, the franchisee model ensures that aggressive expansion plans won’t put a strain on the company’s balance sheet.
2) Realistic Growth Assumptions
Dunkin’s management is targeting a long-term same-store sales growth of 3.5-4% for the Dunkin’ Donuts stores in the U.S., which looks like a realistic and an achievable target. There is an opportunity for the restaurant chain to grow its sales during the second half of the day since the restaurant has traditionally derived most of its sales during the breakfast time slot. At the moment, Dunkin’ Donuts generates only 40% of the sales after 11am, but the management is trying to generate additional sales during the afternoon. 
Some of the recent menu changes made have been done keeping this factor in mind. The company has upped its focus on sandwiches and pretzels – items that the diners are likely to consume during the daytime or during the evening. Examples include Turkey Sausage Breakfast Sandwich, Angus Steak and Egg Breakfast Sandwich, among others. Dunkin’ is also remodeling its existing restaurants to incorporate cushion seatings and TVs in order to attract more customers during the daytime.
Also, since the restaurant addition will occur in relatively newer markets, the new stores won’t cannibalize the sales of the existing ones. This should make the task of achieving the aforementioned sales target easier.
3) Unlocking Earnings Potential
Dunkin’s earnings in the past have been obfuscated by a number of one-time charges that include a loss on debt extinguishment, costs related to secondary offerings, and impairment charges related to South Korea joint venture. Moreover, the company’s earnings are eroded to a large extent due to the high interest expense. For example, in 2012, the company incurred an interest expense of $73.5 million, as a result of which the net income stood at $108.3 million. 
Dunkin raised a significant amount of debt in 2010 at a time when the company was in a precarious position. As a result, it had to pay a very high interest rate (in excess of 9%). With the company in a healthier position, its interest expense should decline in the coming period. Dunkin’ could even refinance some of its existing debt to lower the effective interest rate, as it has done in the past, with the consequent charges on debt extinguishment). As the one-time expenses fade and the interest expense declines, we should see a significant improvement in the company’s net earnings.
In short, the current rally looks justified as more investors realize the true earnings potential of the company. Moreover, due to an opportunity to increase both the same-store sales as well as the store count, future growth assumptions subsume a lower risk.Notes: