Is Dunkin Brands a Buy Ahead of This Week's Earnings?

When it comes to eating donuts, the law of diminishing returns certainly applies. Dunkin Brands (NASDAQ: DNKN) stock enjoyed a nice run from its January 2016 low of $36.44 to its September 2019 all-time high of $84.74. Then too much of a good thing gave investors a stomachache.

A disappointing quarter and the onset of the coronavirus quickly de-caffeinated Dunkin to below $40 per share at its March 2020 worst. It has since ridden the U.S. equity rebound higher and is set to report its first full COVID-19 quarter before the market open on July 30^th. What should investors expect?

Let's just say, like other quick-service restaurants (QSRs), the bar has been set rather low. The Zacks consensus EPS estimate is $0.47 compared EPS of $0.86 in Q2 of 2019. Sales are expected to come in around $274 million, 24% below last year.

But let's keep in mind, this is a company that has topped earnings expectations in each of the last 10 quarters.

Still, with the market not expecting much in the way of Q2 performance, it is management's outlook that will be in the spotlight. For 2021 analysts are forecasting sales and earnings growth of 11% and 19% respectively. These may be conservative estimates from the low 2020 bases.

Pent up demand for Dunkin coffee and baked goods along with increasing customer adoption of digital sales channels suggest Dunkin Brands may have a more flavorful than expected outlook. This could spur upward estimate revisions and propel the stock higher after earnings.

How Has COVID-19 Impacted Dunkin Brands?

With over 13,000 Dunkin Donuts locations across the U.S. and 40 international markets, the 70-year old franchisor is no stranger to the waves of the economic cycle. It also owns Baskin Robbins, the world's largest chain of ice cream shops with over 8,000 locations. Combined the two franchises generated over $12 billion in systemwide sales and opened 385 net new restaurants in 2019.

Turn the calendar to 2020 and a set of unprecedented COVID-19 challenges have forced Dunkin to think outside the donut box.

Dunkin's U.S. locations began limiting service to the drive-thru, carry-out, and delivery on March 17^th. In other words, only the dine-in option was off-limits including outdoor seating.

With these restrictions in place for most of the second quarter, it would seem the sales figure would be lucky to reach the Street's target. But the COVID-19 impact may not be as bad as assumed. This is because most of Dunkin's transactions are carry-out orders anyway. This option has remained opened.

Granted, there have been fewer people buzzing around for their pre-work coffee and bagel fix. And people's concerns around entering any type of food establishment is sure to have put a dent in second-quarter carry-out traffic.

But given that Dunkin' has held the top spot in the coffee category of Brand Keys customer loyalty rankings for the past 14 years, the attrition was likely less than at other QSRs. Meanwhile, promotions like $2 Iced Mondays and Free Donut Fridays seem to have been well digested.

What About Dunkin Brands' Digital Initiatives?

Dunkin Brands took strong steps in digital technology prior to COVID-19. This has put it in a good position to capitalize on accelerated consumer preference for mobile food and beverage ordering.

It launched the DD mobile app, the DD Perks rewards program, On-the-Go ordering, and delivery to make itself more accessible to convenience-hungry customers.

Since the start of the pandemic, Dunkin' has been ramped its digital campaign encouraging its loyal following to order through the mobile Dunkin' app. It also offered an expanded curbside service and began promoting delivery service through Grubhub (NYSE: GRUB) and Uber Eats (NYSE: UBER). Last month it announced an expanded delivery partnership with Uber Eats to bring its total delivery base to more than 4,000 locations. Yes, even Baskin Robbins ice cream can be delivered.

Dunkin Brands has a 100% franchised business model which makes for a simplified corporate structure and an easy to understand investment. It generates revenue from royalty income, franchise fees, and other franchise-related income including rental income from leased properties.

It is also a very asset-light business. Dunkin has a property, plant, and equipment balance of just $223 million out of a total asset base of approximately $3.9 billion.

The model has translated to strong financial results. Over the last five years the company has served up a profit growth rate of 18%.

However, leverage remains a concern. A long-term debt balance of $3 billion gives Dunkin a 122% debt-to-capitalization ratio. By comparison, it exited the first quarter of 2020 with $601.2 million in cash.

 

What's for Dessert?

Dunkin's U.S. stores began to reopen towards the end of the second quarter. In early June, the company announced plans hire up to 25,000 new employees in anticipation of a surge in customer traffic. This pent-up demand may produce a surprise late quarter sales boost.

Given the circumstances, Dunkin Brands appears to have performed well in recent months. The next few quarters could certainly be bumpy as the company tries to regain its momentum of 2016-2019 amid ongoing pandemic uncertainty.

It is, however, in a good position to grow as the economy rebounds. As workplaces, schools, and travel return to the fold, customer demand should be strongly supported by new digital sales channels and national advertising campaigns. When the dust settles, the growth trajectory seen prior to COVID-19 is likely to resume.

Switching gears, the technical analysis points to the potential for a near-term run to the $73 to $75 range. This is based on a short-term bullish continuation wedge pattern that formed on June 29^thwhen the stock closed at $64.58. Moreover, last week Dunkin Brands regained its 200-day moving average, a long-term bullish signal.

Trading around $71 currently, the stock looks like a buy heading into earnings. At around 24x forward earnings Dunkin Brands trades at a significant discount to its sub-industry group average of 32x.

It is also worth noting that hedge fund activity around the stock has picked up in recent quarters. Hedge funds increased their Dunkin Brands holdings by nearly 290,000 shares in the first quarter of 2020 resulting in their highest ownership level of the last two years.

Looking into 2021 and beyond there is plenty of room for cream and sugar. Dunkin has the potential to expand its U.S. footprint, especially outside its core Northeast market. This along with the continued progression of its digital offerings are likely to provide the jolt needed for long-term growth.