Top Stock for March 2014: “The McEmpire is Dying!”

What's Ian Wyatt's company that has better margins than McDonald's and Starbucks?

By Travis Johnson, Stock Gumshoe, March 12, 2014

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That “top stock” headline is the promise of Ian Wyatt, not myself, just to be clear.

Wyatt and Taylor Laundon put out a letter called Top Stock Insights, the text of the ad for that letter says it’s from Taylor and the letter is “signed” by Ian Wyatt, so I guess we’ll assume it’s a group effort … and this is the basic spiel of the letter:

“A rapidly expanding rival is chipping away at the McDonald’s empire…

“it’s opening 8,000 new restaurants and quickly stealing away market share, and profits!

“Get all the details of this “immediate buy” below – and find out why it’s our Top Stock for March 2014….

“… the fast-growing restaurant chain that’s CRUSHING McDonald’s and spreading to every city in the country!”

So who is it? We had several guesses come flowing in the door here at Stock Gumshoe — no, it’s not Chipotle (CMG), that’s too big and not profitable enough for the clues … and it’s not Buffalo Wild Wings (BWLD), also not profitable enough, or Noodles & Company (NDLS) or any of the other “hot” restaurant stocks folks suggested.

I’ll leave you in suspense for just a moment as we wander through the clues …

“You see, unlike McDonald’s, this restaurant chain is growing same store sales – at a 3.75% annual clip – while at the same time it’s adding thousands of new locations (adding new revenue streams each quarter).

“It’s exactly where McDonald’s was decades ago… before it spread into every city across the country.

“Right now, this restaurant chain is really only concentrated in one part of the country – the East.

“People there know it well… but it only has 244 restaurants in the rest of the country – the entire West Coast and MidWest has yet to be introduced to this restaurant chain….

“… management is rapidly expanding… and increasing its restaurant count 20-FOLD in these underserved regions.

“(That’s 5,000 of the 8,000 new restaurants it’s building dedicated to this market.)

“This includes two of the most populous states in the union – Texas and California.

“And the best part is, this company’s business model delivers gross margins of over 80% – that’s the best in the industry…

“And its operating margin of 42% is also best in the group….”

The little graph they showed with comparable operating margins, by the way, puts the number about 39%, not 42%, but these things fluctuate (Starbucks is around 15%, McdDonald’s around 30%, Yum around 15% … the biggest differentiator among restaurant chains tends to be the percentage of franchisees, franchised stores enable the parent to have much higher operating margins since the franchisee handles the operating costs of the physical space).

And a few more specific clues to help out the ol’ Thinkolator:

“When you invest in this company today, you can see a nice return in a matter of months.

“In fact, revenue is expected to grow by 7% in 2014…

“Operating income expected to grow by 11%…

“And EPS (earnings per share) is expected to grow by 17% to 20%…

“Plus, on top of all this growth, this company is extremely shareholder friendly…

“Dividends are expected to grow by 20% this year alone!

“Currently, shares of this company carry a yield of 1.79%. But considering the fact that management continues to raise dividends…

“And that its payout ratio of profits to dividends is the same as McDonald’s (56%) it’s not unrealistic to say its yield could easily double in the years ahead.”

So now that we’ve got a passel of clues under our belt, what’s the answer? Have no fear, I fed it all into the great big hopper on the Thinkolator, set it on “pulverize,” and it wasn’t long before the answer come pouring out … this is New England’s own Dunkin’ Brands (DNKN), owner of the Dunkin’ Donuts and Baskin Robbins brands.

Which those of us in Massachusetts wouldn’t really think of as a “growth” company — here it’s more of a fixed physical presence in every single town and mall, like a traffic light or a post office. I think it might not actually be legal for New Englanders to live more than ten miles from a Dunkin’ Donuts.

But yes, they are paying a small but growing dividend, and their payout ratio happens to match that of McDonald’s at 56% (that means they pay out 56% of earnings as a dividend). And their operating margins are huge, just under 40%, because their stores are overwhelmingly franchisee-owned … that also keeps gross margin up near 80%, though it’s a couple ticks below that at the moment, since it’s the franchisees who pay rent and buy dough and run bakeries and hire counter help, etc.. Gross margin for an individual franchise owner must be very low, but it’s awfully high for the parent company that just collects the franchise fee/royalty and marketing share payments from the restaurant owners.

And yes, same store sales have been growing for Dunkin’, too, which is pretty impressive — whether that’s just price hikes or it also is made possible by their menu expansions, I don’t know (they’re trying to get some lunch business with sandwiches, and have rolled out higher priced breakfast stuff and fancier beverages too). I do know that the donuts are far less tasty than the Dunkin Donuts of my youth, but I guess that’s what mass standardization and factory restaurants do to food. Their same store sales growth in the US is far higher than McDonald’s, as teased, but is actually pretty close to Starbucks recently, in the 3-5% range, so perhaps it’s just that the coffee folks are doing better than the burger sellers.

Dunkin Donuts is an old and well-known brand in the Northeast, and they are pushing expansion both globally and to the rest of the United States — the company has been on a store opening tear for almost a decade now, ever since they were bought by a consortium of private equity companies back in 2006 (they had been sort of a “hidden” asset of a large liquor company before that), which turned them into a franchising machine, and that growth stepped up even more after they were taken public in 2011.

Analysts do think that this $5 billion company will continue to grow faster than the market, they’re predicting roughly 7% sales growth and 16% earnings growth for next year, a slight deceleration from the 19% earnings growth they expect for 2014 … they grew earnings per share by almost 50% last year, so to some degree it might just be the law of large numbers catching up a little bit, it’s hard to post ridiculous earnings growth every year if growth depends, to a large degree, on the physical build-out of new stores and on marketing to new regions. But even 15-20% earnings growth is tremendous, so that keeps investors paying a nice premium for the shares — right now they trade for about 38X last year’s earnings and about 25X 2015 estimated earnings.

The real competitor, I think, is Starbucks (SBUX) — and the valuations are fairly comparable on a forward earnings basis even though SBUX is about 10X larger than DNKN … so if you were looking for a big coffee chain you could go with either the heavily franchised DNKN that is growing slightly slower, or the much larger operator of company-owned stores in SBUX that posts substantially lower margins. Both are valued at about 1.5X their growth rate, which is decent for a growth company — I am personally inclined to like Starbucks as a company much better, largely because it’s so entrenched as a brand, but haven’t been tempted to buy the stock at premium prices (and was too much of a chicken to buy in the low teens last time the stock stumbled)… but I think DNKN probably has more potential for upside growth surprises because of their ability to much more rapidly expand their footprint and because of their much higher margins.

But it’s your money, so what do you think? Interested in investing along with Dunkin’ as they try to colonize the rest of the country? Think it’s too pricey? Let us know with a comment below.


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30 Comments on "Top Stock for March 2014: “The McEmpire is Dying!”"

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Elliot Sedlecky
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Elliot Sedlecky
March 12, 2014 1:52 pm

I’m with you on SBUX, Travis, and while I believe it is a bit expensive, I bought this dip multiple times because I am a very strong believer in the brand and also I have very high hopes for Teavana and also think their food projects have a lot of potential.

Rusty Brown in Canada
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0
Rusty Brown in Canada
March 12, 2014 1:56 pm

“Our little systems have their day,
They have their day and cease to be…”
Tennyson

sonetirot
Member
2
sonetirot
March 12, 2014 2:04 pm

I had been invest in DNKN for a few months via selling PUT. Finally got some 200 shares at extremely good price. Aggressively sell more 45, 47.5 and 50 PUT. Gain more cash. I now push up to $52.5 and want them to PUTs it to me. That would mean I have it at lower price than today price. This is one of my top winner after BOFI (from Stock Gumshoe lead of course)

ges
Guest
0
ges
March 12, 2014 2:15 pm

both have cost of coffee bean issues which the market seems to be ignoring.

mick
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0
mick
March 12, 2014 4:02 pm

going forward I think this is a slam “dunk”

slipnby
Member
0
slipnby
March 12, 2014 4:23 pm
Sometime in the mid 90s I remember buying the DNKN apple flap jack with the crisp & sugary outside, moist, cinnamony inside, flaky dough, ample apple jam filling, about the size of a pie plate. I experienced DNKN a from time to time since and have been consistently surprised how the doughnut quality, size, taste and texture declined substantially visit after visit, and eventually I stopped going to DNKN. I was in the DNKN neighborhood about a month ago, and being curious I bought two donuts. They were dry, almost stale, lacking flavor, and I threw them in the trash…and… Read more »
dealerdeb1
Irregular
22
March 16, 2014 4:35 pm

I agree. I used to LOVE te honey glazed but they weigh about an ounce now, smaller and definitely not as tasty. That being said what I DO see is these strip malls that start with two or three stores , chains mostly then in a year when the fad is over the entire strip is empty. We have had 4 different Dunkins nearby open and close so for me I’d rather have a safer bet. I likek reliable dividends thats just me.

jean
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0
jean
March 16, 2014 11:44 pm

I do agree with you, we had 2 dkd’s and now they’re gone…Tim Horton’s blew them out of water

Geo MArco
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Geo MArco
October 9, 2014 9:54 am
I’m 46 now, but growing up in New Jersey, Dunkin Donuts was great up until about 15 years ago. Flavorful, sweet donuts and hot caffeinated coffee. There were not the glut of stores and kiosks like today, only free standing stores. They used to make the donuts in the store, and had four times the varieties. Sometime about 2005 I think they changed their coffee. Whatever they are doing to it today, it is now much more bitter and not a strong as it used to be. I’m sure the quality of the donuts must have changed when they started… Read more »
Ira Cotton
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Ira Cotton
March 12, 2014 5:33 pm

I hate Starbucks coffee and love Dunkin Donuts coffee! Translation to investment: probably none, but I will take a closer look at DNKN. I love that they mostly franchise – no big investment in fixed assets. Kind of like the Royal Gold or Silver Wheaton of coffee & donuts.

Ira Cotton
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Ira Cotton
March 13, 2014 4:20 pm

There are SIX Dunkin Donut stores in Naples, FL, where I moved last year. I will try a taste test over the weekend and report.

billpopp
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0
billpopp
March 12, 2014 7:48 pm
Can’t imagine that the concept will gain much traction on the left coast where people seem to be more aware of what they put in their bodies. And especially since apparently the product is generally not that tasty per some of the above. Agree that I generally do not like Starbucks coffee but they do own other lines like Seattle’s Best which I prefer (Oh, I think Mc D’s uses that) and have an almost universal cache that attracts the generation X, Y, Z crowd. Dunkin D? I don’t know — who wants to be seen in there?
bill barbour
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0
bill barbour
March 12, 2014 8:56 pm

It seems the national trend is shifting away from “obesity” foods, and donuts are surely on the top of the list. Wendy’s has got the message and looks like a safer bet long term.

John Harris
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John Harris
March 13, 2014 9:26 am
Just don’t forget the stellar rise and subsequent crash of one time stock darling Krispy Kreme. I bought into that on the rise and got creamed (should I have spelt that with a K). They too had fantasy ideas of opening thousands of franchise stores per year but the obesity factor I think put the brakes on them. And yes I too remember the chocolate frosted chocolate dough donuts from Dunkiin Donuts that used to be to die for, (probably some literal truth to that) that now are far from that best in the world quality. But if someone brings… Read more »
Ron Koro
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Ron Koro
March 13, 2014 4:39 pm
Dunkin leaned the 20 min trick (throw out coffee heating more than 20 minutes rule) from Tim Horton’s, saw that signed in some stores about 3 yrs ago. However, individual stores may or may not be honest vs. policy. Tim’s stores mostly are religious about the 20 min. rule. Tim Hortons has major plans to expand in the USA also, you see it in the Northeast, MI, NY, and all down snowbird highways from Canada like Hwy 75. They tried expanding few years ago, so so results, but this time think they are prepared and will be the competition vs.… Read more »
Bambi
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0
Bambi
March 13, 2014 10:31 pm
I live in Chicago and there are LOTS of Dunkin Donuts in the city. I absolutely LOVE their coffee over Starbucks any day. They take your full custom order and mix the cream and sugar in for you before they hand it to you. They have at least 20 free flavors you can add to your coffee (I said FREE) and I love the blueberry the best. They have some really tasty breakfast sandwiches and wraps that run from high calorie to very low. We love the ones made with egg white, cheese and sausage which are under 300 calories.… Read more »
Bonnie
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Bonnie
March 14, 2014 12:02 am

I’m from Boston, just love my ex large ice coffee from DD’s everyday. Their bagels and breakfast are the best. And the ‘drive thru’ YAH ! Own the stock too. But i agree they better cover up those donuts, their getting stale!

pgunda
Member
0
pgunda
March 14, 2014 5:26 pm

I have a dozen DD’s close to where I live and most of them are crowded during the morning. They carry lot more items than just Donuts. I go there frequently but have donuts very rarely. They also seem to catch on the health craze by introducing low calorie flat bread breakfast items.

bobbyb444
Member
8
bobbyb444
March 16, 2014 11:11 am
I live in CT, and have experienced all of the above mentioned coffee-houses locally and on the road leading to the mid-west–and in CA, WA specifically. Problems stem from marketing and franchisee ownership. Krispy Kreme housed itself mainly in mall environments and entrances to major shopping venues. They generally supplied smaller donuts and coffee, and not much else on the menu, and became known for specific donuts. Their parlor extended out into the mall common. Many customers opted for the better variety and coffee quality of DD as their main competitor. Starbucks locates in downtowns, strip malls and intersection corners.… Read more »
harpswell
Irregular
32
harpswell
March 17, 2014 11:56 am

The donuts have gotten worse even within the past few years If you have a family-run donut shop in your neighborhood (I used to stop at Beckers in Polish Village on my way to work) buy their donuts. As a stock, DD may be fine. After all, McDonalds isn’t very good either.

tanglewood
Irregular
170
March 17, 2014 12:21 pm

I can never get an answer from the coffee distributors on this. Does anyone know why they don’t sell coffee bags similar to tea bags. I tried it by emptying a tea bag and putting Peet’s ground coffee in it, re-stapling and it’s not bad. I think of all the coffee that get’s wasted with those Kuerig K cups. It just passes the boiling water thru once. With a bag in boiling water, you can brew to your desired strength.

dcohn
Irregular
159
March 17, 2014 1:45 pm

Supposedly soaking coffee for long periods adds more bitterness and more caffeine but no more flavor.
If you research coffee making I am sure you will find many reasons why coffee is made differently than tea. Especially expresso.

DOug

Kris Prasad
Guest
0
Kris Prasad
March 17, 2014 2:59 pm

Tanglewood:
There is a plunger system coffe-maker.
You put the coffee powder (usually freshly ground) into a glass cylinder, pour boiling water over it and position the plunger just above the surface of the liquid. Then you just push the plunger down , after a period of time (2-4 min), and enjoy the brewed coffee sans the grounds which collect at the bottom

arch1
Irregular
5212
March 17, 2014 3:42 pm

Tanglewood; Keurig sells an optional basket in which you use your ground coffee instead of the capsules preloaded. Also the glass maker with plunger is called a french press & makes excellent coffee but is messy disposing of grounds. I think using freshly ground coffee & boiling water makes the very best cup by using a filter system.

arch1
Irregular
5212
March 17, 2014 12:37 pm

I no longer buy donuts or cookies commercially made since the advent of all the poly-unsaturated nonsense. I will have olive oil on my salad Thankyou , not on my donut. I guess if I want something good,the only reason for eating a donut, I’ll make it myself & eat hot from the grease, or butter in the cookies.

barksducks
Member
14
barksducks
March 19, 2014 6:19 pm

I think if human health is important to you, you have to reconsider buying companies like this, companies that basically market sugar. As a diabetic myself, I won’t invest in a company that pumps out sugar into the general population for pennies a serving. It would be like investing in my own death. For that reason, I own no fast food companies in my portfolio at all.

flyinkel
Irregular
15
May 19, 2014 9:00 pm

I know this is an old thread at this point, but do we really want to invest in coffee dependent stocks right now with the global coffee fungus problem expected to dramatically increase the cost of beans? Just seems like it could eat up any profit potential.

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