DUNKIN BRANDS GROUP Date : August 8, 2017 DNKN: Company Overview (2016 10K) Dunkin Brands Group, Inc. oversees one of the world s leading franchisor operations consisting of 20,242 stores worldwide at the end of its 17Q2 and which generated $11.1B in global systemwide sales in the TTM as of that date. It owns 2 brands: Dunkin Donuts brand (DD) which specializes in coffee, baked goods, and Baskin-Robbins brand (BR) which specializes in ice cream and frozen treats. Operations are organized into a domestic and international segment for each brand. This analysis focuses largely on the DD US segment since it is by far the largest segment by store count, revenues and profitability (see table) and because it also seems to be management s principal focus. 1 / 6
Strategy The company is on the second year of a 5-year 2016-2020 plan announced in late 2015. The plan targets DD US comps of 2-4%, net unit growth of 4-6% which, together, would propel topline at a mid to high single digit pace. The plan also envisions G&A growth at half the rate of revenues and operating earnings growth of 10% annually and with share buybacks EPS growth should average 15%. Management s plan to attain these goals starts with product. Despite the doughnut in its name, the company believes coffee is Dunkin Donuts most important product. That emphasis may be the reason DNKN is reported to be testing a name change to Dunkin. As such it is counting on the success of its dark roast, macchiato/ espresso and cold brew offerings to drive attach rate of doughnuts, breakfast sandwiches and other food items to build average check. It aims for faster innovation and core product quality, though this initiative is as much directed at editing and upgrading an extended doughnut offering as introducing new products. It has joined the industry in deploying technology (common POS platform, digital menu boards, DD Perks, On-the-Go Ordering, curbside and delivery). It is utilizing positive value offers and smart pricing, elements of its drive to expand attach rates. Of course it is striving to improve the restaurant experience (image upgrades, order accuracy, friendly service), and finally, the company is working to expand its CPG business. In addition to its K-cup products, It has grown its ready-to-drink coffee market share to about 10% and it is seeking new channels to develop. The company s goals for BR--similar to the plans for DD US-- aim for product innovation, introducing digital (mobile app) tools and delivery. To that end it has overhauled marketing plans and is experimenting with more attractive franchise offers, including multi-unit offers to its top performers. 2 / 6
However, the company s principal challenge with BR is to return its US segment to growth, and so far results have been disappointing. Store growth has been barely positive, revenues are flat to down slightly and segment profits are also basically flat. The company does not sell supplies and equipment to its DD franchisees. Most of the US and Canadian DD stores are supplied by a non-profit cooperative owned and operated by the franchisees, although the company specifies quality standards and its CFO is a board member. On a regional basis, DD US franchisees also collectively own and operate bakeries to supply fresh baked goods to their restaurants. As such the company feels it avoids the conflicts of being a middleman in the supply chain while enabling the franchisees to obtain maximum purchasing and distribution efficiencies. At its October 2015 Analyst Day management pointed to COGs savings of $100M for DD US franchisees over the previous 4 years to illustrate the productive nature of this division of responsibilities. The savings resulted from a flat pricing agreement with the cooperative, under which franchisees all pay the same delivered price for supplies nationwide. In that 4-year period the average price per delivered case fell from about $29 to about $25.50. The manufacture and distribution of ice cream products to domestic BR franchisees is outsourced to Dean Foods under license, while the company purchases ice cream products from Dean Foods for distribution to international franchisees. The licensing fees are paid to the company. Unit Level Economics The company plan is to double DD US stores to about 19,000. The plan envisions growth in store count to expand westward from its most mature region in the Northeast states (the core region) where its penetration is about 1 store per 8,600 residents through successively less penetrated regions to the Western region where penetration is just 1 store per 282,100 residents. To achieve its ambitions, it expects it can grow its footprint in every region, with the least in its core region (to 1:8,100) and the most in the Western region (to 1:23,800). DNKN s 2015 10-K, DD domestic PODs range in size from 1K-2.5K square feet, from which we estimate average unit volumes of $920K, or about $540/sq.ft. assuming 1.7Ksq.ft. average size. In the 17Q2 conference call management reported the average capex for the domestic DD standalone traditional stores opened in 2015 in the least penetrated (& key to the growth strategy) West and Emerging markets (essentially the Midwest) was $500K and first year AUV s and cash on cash returns were $900K and 20%, respectively, implying a cash contribution margin of about 11.1%. While these returns are a slight improvement over the units opened in prior years, they are not attractive. Perhaps they grow to more attractive levels as the stores mature, but they may also explain the slowing pace of franchise investment in the past 2 years. Perhaps franchisees are awaiting the introduction of a new store prototype. In 17Q2 the company said it was reducing new store guidance somewhat in 2017, partly because it will be introducing a new prototype soon. It also said that a large number of stores are reaching their 10-year mark which will require 3 / 6
remodeling under the franchise agreement. It said it was examining ways to help franchisees allocate capital between new stores, remodeling and the investments in new digital initiatives. In this regard the company appears to be contemplating co-investing with franchisees of both brands to accelerate development, but had not announced any initiatives yet. BR and international unit level information is a little sparse. BR domestic units range in size from 600-1,200 square feet, from which we estimate AUV s of $235K or about $260/sq.ft., assuming 900 sq.ft..average size. At the October 2015 Investor Day, management revealed BR units opened in 2014 generated AUV s of $365K, that the cash outlays for the units ranged from $200-$225K and the cash on cash returns ranged from 20% to 25%. At the midpoint the implied store level EBITDA margin was about 13%. These margins are only slightly more attractive than DD US, but the company has not provided more current returns as it has with DD US. Even so they evidently are not attractive enough to entice franchisees to step up their investments. Balance Sheet and Cash Flows DNKN generates impressive free cash flows, a testament to its exceptionally asset-light version of the franchise model (100% franchised, no owned supply chain infrastructure). As of 17Q2 TTM free cash flows were $248.1M (CFO $260.1, CapEx $$12.0M), or 29.8% of revenues. These cash flows have financed about $500M in dividends and $1.4B of stock buybacks since the company s IPO in 2011. The ratios of debt to EBITDA and lease-adjusted debt to EBITDAR is 5.3X and 5.6X, respectively which are both about a turn above the averages peers with systems 90% or more franchised (DENN, SONC, WEN, DPZ, PLKI, WING DIN). Shareholder Returns Since DNKN s IPO in July 2011, the stock has appreciated 82.3% (10.5% CAGR) and the total return with dividends reinvested is 104.7% appreciation (12.7% CAGR). DNKN: Recent Developments (17Q2 Release) (17Q2 Slides) (17Q2 Transcript) Second quarter highlights included US comp sales of 0.8% at Dunkin Donuts and negative 0.9% at Baskin Robbins. Internationally, Dunkin comps were down 2.8%, with BR comps up 3.3%. EPS progress is described in the table above but royalty income at the Dunkin U.S. segment was up 6.3% with franchise fees up 7.8%. Internationally, Dunkin royalty income was down 1.4% and franchisee fee were down 44.%. Within the BR segment, US royalty income was up 2.9% and franchisee fees were up 12.9%. The BR international segment showed royalty income up 5.3% and franchise fees up 24.8%. In Q2 there were 64 net new Dunkin units and 12 new BR locations in the US and 57 net new international locations. In terms of targets, while guidance was not changed for revenues, operating earnings or earnings per share, quite a few operating parameters were guided downward. Dunkin Donut franchise opening expectations was reduced to 330-350 net new restaurants versus 385 previously. Same store sales for 2017 are expected to be LSD at DD US, unchanged, but slightly negative comps at 4 / 6
US BR vs. LSD previously. International unit growth is now expected to be 50-100 across both brands, vs. 200 previously. GAAP diluted EPS are still expected to be $2.22 to $2.30 per share, with diluted adjusted DPS at $2.40 to $2.43. In general, emphasis continues to be menu innovation, improved convenience for customers through digital technology, menu and operational simplification, strategic new unit development and sale of products through non-restaurant channels. Management took some comfort from the 0.8% DD US comp, an improvement over Q1, but DD still lags Starbucks by virtually every yardstick, as Starbucks now bemoans comps that have slipped to MSD. Management pointed out that the 2015 cahort of traditional new stores in the west and emerging regions generated about 20% C/C returns, great news in their opinion, but obviously not high enough to stimulate an acceleration in new unit growth. Drive thru locations, as well as curbside delivery are now a focus, with delivery and catering tests continuing. The DD Perk loyalty program is making progress, with 500,000 members added in Q2, the total program now at seven million. Cash generation continues to be substantial, with $78 million of free cash flow generated in Q2. $29 million was paid out in dividends and $100M was spent, at $56.90 per share, on an accelerated stock repurchase program. An analyst asked about the possibility of DNKN financing franchisee renovation or store development in some manner, but management was non-commital. There was a brief conversation relative to cannibalization of existing stores as new locations are added to a market, which presumably would be negatively affecting comp sales. Management responded, mildly supporting that notion, but our observation is that successful brands build comps at existing stores over time, as overall top of mind awareness builds. We don t know for sure, but suspect that Starbucks has had positive comps in Manhattan, even as they have built out 200 locations over the last 15 years. Conclusion Despite definite signs of promise with DNKN s evolution to a beverage-led concept, we remain concerned with the continued negative traffic. This could be a response to higher prices, a loss of legacy customers who just want ordinary drip coffee and donuts, or a reflection that the strength of the concept is confined to the Northeast. Put another way, since some of the newer products are setting sales records, other product declines are creating the losses in traffic and a flat ticket. Secondly, unit growth continues to be unimpressive at 3-4% though the Company is aiming higher. Certainly, the 5% net unit growth rate averaged over the last 3 years isn t representative of failure, but with most of the country virgin territory for DD stores, the growth could be faster if the stores were generating high returns to the franchisees. We have to assume that the franchisees would like more than the 8% EBITDA margins or 20% cash-on-cash returns reported by the company to step up their pace of investment. Our studies indicate that franchisees (other than one off rent a job operators) need minimum EBITDA margins in the low- to mid-teens and cash-on-cash returns exceeding 25% to encourage expansion. Put another way, at the unit level economics metrics 5 / 6
Powered by TCPDF (www.tcpdf.org) Lipton Financial Services reported by the company, the internal rate of return over the 20 year franchise would be about 6% and would probably be negative with significant maintenance capex or a remodel were figured in. Furthermore, the minimal unit growth by well established franchisees is likely a reflection that, while older locations are solidly profitable, new stores cannot be adequately profitable based on current costs, especially real estate and labor related. Finally, we continue to be concerned that DNKN management continues to use a very large portion of free cash flow to repurchase stock in the open market, at a price (in our opinion) that is far from a screaming bargain. We suggest that, in the long term interest of the franchise system, management might better allocate a larger portion of operational cash flow toward systemwide operational needs, or, alternatively, financial support of necessary franchisee capital expenditures. 6 / 6