Dunkin' Brands' Most Important Task in 2018

Investors in quick service restaurants (QSRs) often focus most closely on the visible metrics that relay a quick sense of an organization's health, like comparable-store sales growth, or units added during a quarter. These types of headline numbers tend to drive immediate reactions from shareholders when quarterly earnings get released.

But depending on how a QSR is structured, less frequently discussed measures and areas of emphasis can have as much, if not more influence on a company's financial success -- and ultimately, its stock price.

Dunkin' Brands Group (NASDAQ: DNKN) follows a nearly 100% franchised model, and thus the success of the individual owner-operators and larger franchisee groups in the Dunkin' Donuts and Baskin Robbins systems form the basis for investors' returns.

This year Dunkin' outlined four strategic areas designed to improve the unit-level economics of Dunkin' Brands' U.S. franchisees, a group which accounts for 76% of the organization's revenue. In 2018, the company's most important task will be to execute the specific objectives which directly boost these franchisee returns.

The relationship between speed and cash

The strategic focus areas Dunkin' Donuts U.S. outlined this year are as follows: menu innovation, restaurant simplification, digital-led convenience of customer experience, and broader brand accessibility through location growth packaged goods sales. Much of the practical focus of these initiatives (outside of broadening the brand's reach) is on speed.

Why speed? Dunkin' is trying to market itself as a "beverage-led, On-The-Go" company, so naturally, improving quickness of service makes sense, as it supports brand positioning.

But a deeper reason is also present, in that an improvement throughput (the rate of sales during a specified period of time) increases cash flow to franchisee-owners. And cash flow is an all-important metric from the perspective of Dunkin' Brands' franchisee base.

Where you or I might think that revenue and profit are foremost in the owner-operator's mind, cash flow, at least in the initial stages of franchise operation, can be more relevant to operators in the QSR industry.

Specifically, store owners look to their "cash-on-cash" return on investment to gauge success under a franchise banner. Cash-on-cash return is typically the positive cash flow a location generates after debt service, divided by the owner's initial cash investment in the store.

In its most recent investor presentation, Dunkin' Brands shared cash-on-cash returns for a specific cohort of stores: Those opened in 2015 in the "Emerging" and "West" regions, which together cover most of the Dunkin' U.S. territory outside of the northeastern states and Florida. These stores are averaging approximately 20% in annual cash-on-cash returns -- an extremely attractive return.

Maintaining and lifting this return on investment will help Dunkin' entice new franchisee investment as it expands in the open slate of western states, where only 5% of more than 9,100 locations are currently located.

Same playbook, more execution in 2018

Dunkin' Brands' attention to franchisee returns is the overarching principle behind experimenting in 2017 with pared-down menus, slimmer store format designs, and higher prevalence of drive-throughs, which I've described recently in more detail.

Executing the specific initiatives that result in smaller, faster, more profitable stores isn't simply the most important task for Dunkin' Brands in 2018 -- it's the activity which will most directly enhance long-term shareholder value.

That's because, as a totally franchised company, Dunkin' Brands has chosen to forego revenue from operating its own stores, and instead relies on franchisee fee and royalty income as its primary revenue stream.

This "asset-light" model works best when a management team realizes that bumping up franchisee unit level performance is the most direct route to improving the organization's own bottom line.

Dunkin's' executive team largely grasps this principle, and it achieved some wins in 2017 by guiding operators to compete more fiercely during the all-important breakfast hours, to name one example. Success in 2018 will be defined by more competitiveness, more speed, and more cash flowing to Dunkin' Brands' U.S. franchisees.

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Asit Sharma has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends MA. The Motley Fool recommends Dunkin' Brands Group. The Motley Fool has a disclosure policy.