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Why Dunkin' Brands Is Set to Beat the S&P 500

- By Robert Stephens, CFA

An increasing focus on menu innovation could catalyse the stock of Dunkin' Brands Group Inc. (DNKN). It is introducing a range of products that are attracting new customers and leading to cross-selling opportunities.

Although the company faces a high level of competition, its refreshed restaurant layout as well as investments in digital growth and delivery could enhance its competitive advantage.


Having risen 13% in the last year versus a gain of 4% for the S&P 500, the stock could record further outperformance of the index.

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Innovation

An increasing focus on menu changes is providing new growth opportunities for the business. For example, the relaunch of its handcrafted espresso drinks has led to a 30% increase in sales within the category. The relaunch has also brought new customers into Dunkin' restaurants, which has provided cross-selling opportunities. This has coincided with the release of its signature latte line, which could widen the appeal of the brand to new customers at a different price point.

Dunkin' Brands is also innovating across its new Go2s value menu, which includes three of its most popular breakfast items. This has encouraged a higher average ticket per transaction, standing at over $8 in the most recent quarter. The company plans to release additional products that capitalize on increasing demand for healthier options following the success of its Power Breakfast Sandwich. Increasing its exposure to the better-for-you category may allow the company to resonate with consumers at a time when 55% of Americans are reporting they are working to lead healthier lives.

Growth prospects

Expanding its number of locations across the U.S. could catalyze the company's financial prospects. In the fourth quarter, for example, it added 34 net new stores. It expects to open over 200 new locations this year. In addition, Dunkin's refreshed restaurant format, which is being implemented in all new locations, is helping to generate encouraging returns when compared to the previous restaurant layout.

Dunkin' Brands is also looking to improve the customer experience at its international locations. The new cafe design has been implemented in 250 locations through new-builds and remodels. So far, the new layout is resonating with customers, leading to higher beverage sales.

The customer experience is also expected to improve through the rollout of multi-tender at over 1,000 restaurants. This allows customers to earn DD Perks points as part of the company's loyalty program regardless of how they pay for their items. This is expected to grow the loyalty program beyond the current 12% of sales over the long term.

Risks

Lower traffic continues to act as a drag on the company's sales performance. Although it has been able to offset the decline with higher prices, lower traffic is expected to remain a near-term concern. One reason for this is the range of choices available to consumers as the quick-service restaurant industry is highly saturated. Another reason for disappointing traffic growth is the ongoing difficulties at the company's Baskin-Robbins ice cream parlors. Three locations closed in the most recent quarter.

In response to a high level of competition, Dunkin' Brands is seeking to increase convenience. It has secured a perpetual license to the code that runs its mobile app, which will provide it with greater flexibility and reduce time-to-market with upgraded features. It is also investing in opportunities such as On-the-Go Mobile ordering to reduce wait times for guests, while also expanding its delivery initiative with GrubHub (GRUB) in order to increase the accessibility of its products to a wider range of consumers.

Outlook

Dunkin' Brands is expected to post a 7% increase in earnings per share in 2019, followed by 8% growth next year.

Although the company's price-earnings ratio of 27 is relatively high, its growth strategy could lead to improving stock price performance.

The investments it is making in menu innovation could attract new customers and lead to cross-selling opportunities.

The changes being made to its restaurants and an increasing focus on convenience may provide greater differentiation versus peers in a crowded marketplace.

After outperforming the S&P 500 over the last year, Dunkin' Brands appears to offer investment potential.

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This article first appeared on GuruFocus.