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America Runs on Dunkin' and So Should Your Portfolio

Tuesday - 8/27/2013, 8:51am  ET

Value investors are constantly on the prowl for companies with huge growth potential, but it is not always easy finding one that is safe enough for a large investment. These plays are often made on speculation and carry smaller investments, which, in turn, makes for smaller capital gains. However, when you find a company with established brands, high earnings growth, and a dividend to boot, you have found a yourself an absolute goldmine. Dunkin' Brands  Group  fits this description and has had a big run over the last year, but the earnings expectations predict this is only the beginning.

The brands

Dunkin' Brands Group owns, operates, and franchises quick service restaurants under the Dunkin' Donuts and Baskin-Robbins brands. Dunkin' Donuts is the world's largest coffee and baked goods restaurant and Baskin-Robbins is the world's largest specialty ice cream chain. Being home to two of the world's leading brands gives Dunkin' an edge in the industry. 

Last quarter

On July 25, Dunkin' Brands reported second quarter earnings and the results were mixed, but impressive.

  Reported Expected
EPS $0.41 $0.40
Revenue $182.49 million $183.09 million

Earnings per share and revenue rose 24.2% and 5.9% respectively, while quarterly profit soared to $40.8 million from just $18.5 year over year. The highlight of this report was the higher-than-expected domestic same-store sales; Dunkin' Donuts increased 4% and Baskin-Robbin's increased 2.6%. The increased sales were not from higher prices, but from a rise in the average ticket by its customers; this can be credited to the constant innovations driven by consumer demand.

The wild wild West

With more than 7,000 Dunkin' Donuts locations in North America, shockingly there are zero in the western United States. Baskin-Robbins has been very successful in this area, but its sister brand never made its way over. However, this is set to change very soon. On July 25, Dunkin' reported its deal with 4 franchise groups to open 45 restaurants in California in 2015, just weeks after the first deal for 18 restaurants was signed. California is only the beginning as Dunkin' Brands has a long-term goal of having over 15,000 locations in the United States. This projected store count would more than double its domestic royalty income, cause a spike in franchise fees, and provide more capital toward marketing and adding company-owned locations. Expansion and innovation are two core characteristics of great companies.

Future expectations

In its second quarter report, Dunkin' projects earnings per share to be between $1.50-$1.53 in 2013, in line with analyst expectations. This growth is not expected to slow up anytime soon either. Take a look at the earnings projections, provided by TD Ameritrade, through 2015:

2013: 19.5% growth

2014: 19% growth

2015: 18.7% growth

According to Yahoo! Finance, the industry average price-to-earnings multiple of restaurants companies is 27.17. This means that if Dunkin' Brands were to trade at the industry average multiple in 2015, the stock would surpass $58 per share. However, with expansion being ignited in the West in 2015, it has the potential to continue trading at its current multiple of 36; this would propel the stock well beyond $75 per share. Potential gains like these cause value investors to salivate.

Return to shareholders

Dunkin' currently pays a $0.19 quarterly dividend, resulting in a yield of roughly 1.8% annually. It was increased from $0.15 in 2012, so there is a strong possibility for more raises in the future, as long as free cash flow continues to rise. Healthy dividends are hard to find in high-growth companies.

In the second quarter, Dunkin' repurchased approximately 400,000 shares of its common stock. There is another $33 million remaining for repurchases under previous buyback authorizations. By reducing the share count, earnings per share will increase, making the remaining shares more valuable.

Dividends and share repurchases are two of the most bullish moves a management team can make and both dramatically benefit shareholders. With management expecting $125 to $135 million in free cash flow for fiscal 2013, the dividend could be increased and another round of repurchases could be authorized.

Industry competition

Starbucks  and McDonald's  are the two main competitors of Dunkin' Brands. All three are quick-serve restaurants aimed at being the consumers' number one choice for coffee and food. However, Dunkin' Donuts dominates as the top retailer for coffee in America, as well as being the number one baked goods and coffee chain in the world.

Company

Dunkin' Brands

Starbucks

McDonald's

Market Cap

$4.61 billion

$53.1 billion

$95.8 billion

P/E

36.95

33.8

17.5

Forward P/E

23.80

26.6

15.7

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