“Buy what you know” is the often repeated idea that Peter Lynch suggested in his writings. He said that it doesn’t always work, but in most cases, if you love the store, you’ll love the stock. This brings me to a company my family and I have a lot of first hand experience with, Dunkin Brands Group Inc (NASDAQ:DNKN). Dunkin Brands is home to the Dunkin Donuts and Baskin-Robbins chains, and with family from New England, Dunkin is a household name. The company faces some challenges, but when I really dig into the numbers, there is one thing that sets this company apart from their competition.
Don’t Dare Call Them Krispy Kreme
I’ve read more than one article about Dunkin Brands where someone, who apparently wasn’t from New England, suggested that Dunkin was just another Krispy Kreme Doughnuts (NYSE:KKD). This has been a popular myth surrounding the company since their IPO. Commentators would have investors believe this is just another doughnut shop that happens to sell coffee. Further, they would suggest that as more customers get health conscious, they will avoid doughnuts in favor of healthier options. My only reply to this thought process is, have you ever been to a Dunkin Donuts?
The real situation is this, Dunkin Donuts brand means so much more than doughnuts. In New England, if you are going to get coffee, it’s implied that you are headed to Dunkin. In addition, it’s just as likely that a customer will order a veggie flatbread sandwich, or a toasted bagel, as a doughnut from the store. Where Krispy Kreme is famous for their doughnuts, Dunkin is famous for their coffee and sandwiches.
Who Are The Real Competitors And What Makes Dunkin Different?
Dunkin’s real competition are companies like Starbucks Corporation (NASDAQ:SBUX) and Panera Bread Co (NASDAQ:PNRA), and to a certain extent Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR). Starbucks and Panera both offer pastries, coffee and other beverages, and sandwiches that go head to head with Dunkin. Green Mountain on the other hand, offers customers the ability to brew multiple flavored beverages at home so they don’t have to go to Dunkin.
One way to compare these companies is by their projected growth rates for the year 2013. Since each company has reported earnings, we get updated numbers directly from management’s mouth. Take a look at what each company is suggesting for EPS growth for this full year:
|Name||Dunkin Brands||Green Mountain||Panera Bread||Starbucks|
|EPS Growth Projection||
15.6% – 17.9%
|At least 13%||17% – 19%||15% – 20%|
As you can see, each of these companies is projecting good growth in the next year, with Panera seeming to lead the way. Looking at Dunkin Brands, they appear to be near the top tier, and depending on how things shake out, they could come out on top.
Same-store sales growth is yet another way to compare companies in this industry. Dunkin Brands expects 3% – 4% growth at Dunkin Donuts, and 1% – 3% growth at Baskin-Robbins. By comparison, Starbucks expects “mid-single digit comps, and Panera is suggesting roughly 5% comps as well. It looks like Dunkin is within range of their competition again.
What makes Dunkin completely different is their margins. Dunkin’s competition have operating margins of 14.5% at Panera, 14.5% at Green Mountain, and 16.6% at Starbucks. By comparison, Dunkin’s operating margin in the current quarter was 41.90%. This makes a huge difference in Dunkin’s ability to generate free cash flow from their sales.
It’s All About The Cash
Dunkin’s higher operating cash flow leads to significant free cash flow generation even though sales growth might not be that impressive. The reason is, Dunkin Brands is nearly 100% franchised. This means the company can expand quickly on its franchisees money instead of using its own. The fact that the company retired nearly 11% of their diluted shares in just the last year is proof of the power behind Dunkin’s cash flow. While Dunkin was busy retiring shares, they also have been paying a dividend, and they just announced a 27% increase in the payout. Though the company’s free cash flow payout is 61.77%, the free cash flow generated from new franchisees should allow the company to expand this payout in the future.
The difference in cash flow quality is what makes Dunkin’s stock misunderstood. On the surface, shares might seem expensive at about 24 times projected 2013 earnings. Since Starbucks trades for 26 times earnings, and Panera trades for 23 times earnings, some investors might assume they are better values. However, Dunkin pays a dividend where Panera does not, and Dunkin pays a better yield than Starbucks.
While it would be easy to make a case that Green Mountain is a better value at 16 times earnings, with a near 19% expected growth rate, Dunkin has a longer-term and less disrupt-able franchise. Green Mountain must rely on innovation and constantly stay on the offensive to fend off competitors. Long story short, Dunkin has a unique business model. If the company continues to deliver significant cash to shareholders through dividends and share repurchases, long-term investors should be happy with the results.
The article The 1 Number That Sets This Company Apart originally appeared on Fool.com and is written by Chad Henage.
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