How Sweet It Is!

 | Feb 05, 2013 | 5:00 PM EST
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Last week I tweeted that shares of Dunkin' Brands (DNKN) have outperformed Starbucks (SBUX) year-to-date and over the past 52 weeks. The formula for this outperformance is linked to the company's non-stop new-product launches and aggressive new-store rollouts. If Dunkin' can hit its stretch goal of increasing its store count by 5% annually over the next five years, I believe the stock will go much higher.

Dunkin' Brands, which includes Dunkin' Donuts and Baskin-Robbins, is on a roll. On Jan. 31, the company reported full-year 2012 results. During the fourth quarter, same-store sales grew 3.2%. For the year, the company added a staggering 665 new restaurants, including 291 net new Dunkin' Donuts in the U.S. Fiscal 2012 revenue was up 6.1%, net income grew 15.3% and earnings per share rose 38%. Unadjusted operating margins rose 370 basis points to 36.4%. (Adjusted operating margin was 46.3%.) And for the one-year period ending Monday, the stock is up 27%. Holy cow! It's just donuts, coffee and ice cream. You'd think they were making something people need.

One of the keys to Dunkin's success is its customer base, which is distinctly different from Starbucks. Dunkin' really knows its customers and is able to drive same-store sales with a constant stream of product innovations. For example, coffee sales rose because of a slew of new flavored hot and iced espresso beverages. Breakfast, which Starbucks has bungled for years, keeps cooking for Dunkin'. Sales of limited-time-only smoked sausage breakfast sandwiches, bakery sandwiches and K-cup portion packs keeps customers coming back for more. Management is trying the same tricks at Baskin-Robbins, which offered holiday-inspired ice cream flavors such as Pumpkin Pie, Peppermint and Winter White Chocolate. Other limited-time offerings included the Warm Belgian Waffle sundae and a variety of limited-time-only take-home pints and quarts of ice cream. The heavily advertised "limited time-only" offerings may seem like a gimmick, but Dunkin' customers love it.

The other key to Dunkin's performance comes from its aggressive new restaurant development. Wall Street loves new store growth and Dunkin' has big plans to blanket the world with coffee and ice cream stores. While it does own and operate a few restaurants, Dunkin' franchisees are doing the heavy lifting. To get to 15,000 locations from 7,000 in the next five years, Dunkin' has focused on brand building and franchisee profitability. The company's long-term goal is to be 100% franchised.

By focusing on national advertising and brand building in parts of the country that do not have many locations, Dunkin' has been able to drive brand awareness, which has led to a frenzy of new store openings. With the cost of building a new restaurant between $460,000 and $470,000, franchisees are always looking to latch on to a profitable concept. (The average location does $858,000 in revenue.) But expanding its reach west is only one part of the equation. Dunkin' has been very successfully opening new stores in emerging markets, like Korea, the Middle East, China, India and Vietnam. Baskin-Robbins has even started expansion plans for Ecuador and Indonesia. Seems no place is too emerging for Dunkin'.

The company recently announced plans to make a major push west. It plans to enter the Southern California market by opening between 330 and 360 new locations. Globally, Dunkin' plans to open between 700 and 860 new restaurants in 2013.

Wall Street forecasts fiscal 2013 revenue of $713 million and earnings of $1.52 per share. I believe DNKN shares will go higher as the company turns coffee, donuts and ice cream into a monster momentum story. Just the push to build new locations out west should move the stock to the low $40s from its current price around $36.

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volatility is quite low here, and we could see some downsides here in the short term. ...



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