What Dunkin Brands Group Inc. Investors Need to Know After Shares Tanked 13% In December

By Markets Fool.com

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Source: Wikimedia Commons.

Just three years ago, Dunkin' Brands was the next great growth stock. The market fell in love with the doughnut maker's growth story after the company's 2011 initial public offering. At that time, investors sent Dunkin' shares soaring more than 50% on their first day of trading. The rally continued, and Dunkin' Brands soon turned into a high-multiple growth stock akin toStarbucks .

Now, though, it appearsinvestors have fallen out of love with Dunkin'. The stock is near its 52-week low, falling 8% on Dec. 18 alone after the company loweredits 2015 earnings guidance. Dunkin' expects approximately $1.89 in earnings per share next year, which falls well below analysts' consensus expectation for $2.02 per share. But while the stock isdown 13% year to date, the growth story is far from over. Disappointment with Dunkin' based on missing analyst projections for next year ignores the bigger picture.

Here are a few important things investors should keep in mind about where Dunkin' is, where it's going, and why its biggest problem might be Wall Street and not its underlying business.

Aggressive new restaurant openings
Dunkin' Brands operates more than 11,000 Dunkin' Donuts shops and more than 7,400 Baskin-Robbins ice creameries.With such a massive presence, spread across 60 nations, it might seem Dunkin' is on the verge of market saturation, and these fears were exacerbated by management cutting its growth forecast for next year. But Dunkin' is not nearly as pervasive as one might think.

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One major opportunity still in front of Dunkin' is California, where the company justopened its first full-expression restaurantsin September. More broadly, Dunkin' is not nearly as concentrated in the western United States as in other parts of the country. In Dunkin's core market, primarily the northeast United States, there is a Dunkin' Donuts for every 9,000 people. In the West, which basically encapsulates everything west of the Mississippi River, there is a Dunkin' Donuts for every 500,000 people. This leaves huge potential for new openings, and Dunkin' will pursue that opportunity. Over the next several years, the plan is to open 250 restaurants in California alone, with the long-term goal of eventually opening 1,000 restaurants in the nation's most-populous state.

A unique benefit of Dunkin's business model is that it has much more real estate flexibility than the typical quick-service restaurant chain. It does not rely exclusively on free-standing restaurants; to help its aggressive growth initiative remain as profitable as possible, it uses a wide range of store concepts. These include gas stations, universities, and convenience stores. This flexibility helps keep costs low and returns high, which makes Dunkin's aggressive growth strategy economically viable.

Sound economics provide the foundation for growth
Dunkin' Brands management saysa new store opening requires $450,000 ininitial capital expenditures. This compares very favorably to the $936,000 in average unit volume per store. The company's cash-on-cash returns, a metric typically used in analyzing real estate transactions which compare income generated as a percentage of total investment, are 25%. This is up 20 percentage points since 2008. Earnings before interest, taxes, depreciation, and amortization as a percentage of revenue has increased by 8 percentage points in this time as well. From this, it's clear Dunkin's growth strategy has not come at the expense of margins. In fact, profitability is accelerating, which makes it entirely sensible for management to aggressively open new locations.

This is a critical point Wall Street seems to be missing. Dunkin's strategy of pressing new openings carries such favorable economics that overall growth remains strong, even if comparables disappoint. Its forecast for next year still calls for 8% earnings growth and at least 15% growth in free cash flow. Comparables are likely to grow at just 1%-3% for both the Dunkin' Donuts and Baskin-Robbins concepts, but Dunkin's broader growth story remains alive and well thanks to the combination of top-line growth and expanding margins.

Dunkin's biggest problem: Wall Street
In short, it seems Dunkin's biggest hurdle is the overly ambitious expectations that were embedded in its lofty valuation. Its stock price is valued on par with Starbucks', at about 22 times next year's earnings, which is a bit unrealistic. Starbucks generated 6% domestic comparable growth in fiscal 2014, so it's probably natural for Dunkin's multiples to come down. But that doesn't mean Dunkin's share growth is over. In fact, should the stock continue to decline, Fools might have a great buying opportunity in front of them, because there is significant value to be had from this stock with high returns on each unit built increasing shareholder value.

The article What Dunkin Brands Group Inc. Investors Need to Know After Shares Tanked 13% In December originally appeared on Fool.com.

Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.