Dunkin’ Brands (NASDAQ: DNKN) is scheduled to announce its Q2 earnings on July 24.  The company runs both the Dunkin’ Donuts and Baskin-Robbins chains. The company reported mixed results in its previous quarter, as comparable store sales growth for Dunkin’ Donuts U.S. declined to 1.2 % compared to the 1.7% achieved during the same period last year, primarily due to adverse weather conditions in North America. On the other hand, the company witnessed a 6.2% increase in total revenues, due to the increased sales of ice cream products as well as increased royalty income. 
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 its first month. Dunkin’ Brands is planning to take this to a global scale in the coming years. The American global doughnut and coffee chain is also facing increased competition in the breakfast category. As a result, the company is focusing on revamping its breakfast menu along with other innovative additions to the regular menu. Moreover, the QSR industry faces threat from fast-casual restaurants in terms of customer traffic. 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.
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After mediocre results in the first quarter, the company reaffirmed its targets for the fiscal year (FY) 2014. Dunkin’ is targeting a comparable sales growth of 3%-4% for Dunkin’ Donuts U.S. and 1%-3% for Baskin-Robbins U.S., with a 6%-8% growth in revenues for FY 2014. The company plans to open 380 to 410 net new Dunkin’ Donuts U.S. stores and 5 to 10 Baskin Robbins U.S. stores by the end of this fiscal year, whereas it plans to open 300 to 400 new restaurants internationally across the two brands.
Rising Commodity Prices To Affect Top-line Growth
Over the last 6 months, rising coffee bean prices has created trouble for top Quick Service Restaurants (QSR) and other brands dependent on coffee for revenue growth. 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 prolonged drought in Brazil, followed by recent floods.  Moreover, prices of other commodities such as dairy products and sugar are showing an uptrend too. 
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. However, 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.  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 might contribute slightly to the revenue growth as the move was completed in the last month of this quarter. However, this might help in maintaining the margins for the Dunkin’ Donuts U.S. segment.
Increased Competitive Activity
- Breakfast Category: Low Ticket Could Attract Customers
Dunkin’ Brands is one of the major restaurant brands in the QSR industry fighting for the breakfast market share. 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.
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. The company is optimistic that its breakfast sandwiches and differentiated beverages will help them gain the breakfast market share in the second quarter. With the weather playing no role in second quarter and low ticket of its breakfast menu, an increase in customer traffic as compared to first quarter can be expected. This might help the company in steady sales growth.
- Fast Casual Restaurants Stealing Customer Traffic From QSRs
Fast casual restaurants such as Chipotle Mexican Grill (NYSE:CMG) and Panera Bread have started eating into the market share of these leading QSR chains for the last couple of years. According to Technomic’s 2014 Top 500 chain restaurant report, sales for fast casual chains grew by 11% and store count by 8% in 2013. The revenue growth has been consistently at around 20% for Chipotle for 5 years now. 
According to the NPD group, the fast casual segment saw an 8% rise in the guest count in the 12 month period ended in November last year, whereas traffic count was flat for quick service restaurants.  This consumer shift is primarily due to the fact that people with higher disposable income are inclined more towards quality and hygienic food. A decreasing customer count might hinder the company’s sales growth.
The next few quarters would be very crucial for QSRs such as McDonald’s, Dunkin’ Donuts and Subway, where the industry would be reacting to increasing commodity prices on one hand and changing consumer preferences on the other.
Expansion Into Western Markets: Scope For Potential Growth
The company has plans to expand in the western markets, 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. According to Nigel Travis, company’s Chairman and CEO, Dunkin’ Donuts is slated to open 4-5 restaurants in California by the end of fourth fiscal quarter, much earlier than its original expected date. 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. 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.
The company’s competitors such as Starbucks (NASDAQ: SBUX) and McDonald’s Corporation (NYSE: MCD), leading brands in terms of coffee sales, are dominant forces in the western markets. This might hinder the company’s growth rate in the initial period but with a strong brand appeal and even stronger marketing strength, the company expects an exponential growth once it picks up pace.Notes:
- Dunkin’ Brands Q2 2014: Earnings conference call [↩]
- Dunkin’ Brands Q1 2014, Earnings call transcript [↩]
- Coffee futures, July contract, 2014 [↩]
- USDA report: World refined sugar price [↩]
- Dunkin’ Brands to raise coffee prices [↩]
- How the fast casual segment is gaining market share [↩]
- Fast casual leads traffic growth again, NPD group [↩]
- Dunkin’ Donuts announces locations of its restaurants in California [↩]