Go West, Growth Stock Investors

I like a lot of companies that have overseas exposure. But man, the trend is that most of these stock markets are headed in the wrong direction.
China’s Shanghai Composite Index is still up around 15% this year, and by 80% over the past two years. But the in-process crash has obliterated the 60% gain that was in place from the beginning of the year through mid-June. And any investor that placed bets on the Shanghai since April is in the red.
Overseas concerns are even dragging down U.S. indexes. The Dow Jones Industrial Average and the S&P 500 are both trading right round their 200-day moving averages, a trend line that is usually only breached during relatively significant market pullbacks.
But in stark contrast, more growth-oriented U.S. indexes – including the Nasdaq and the Russell 2000 small-cap index – are holding up much better. This somewhat divergent performance suggests that investors are wise to stick with growth and technology stocks during this market downturn.
One company that I’ve been a long-time supporter of to play U.S. growth is Dunkin’ Brands (NASDAQ: DNKN). The company is set to report earnings later this month, and I’m going out on a limb and stating that I expect the company to beat expectations and confirm that accelerating growth is indeed in process.
I want to fill you in on the details of the company now so you’re in position to buy shares if it fits in your growth-oriented portfolio. I should also mention that it pays a nearly 2% dividend, so it’s good for dividend-growth stock investors too.
Dunkin’ Brands has always been a favorite company of mine. And it’s arguably the most attractive name in the quick-serve restaurant space – especially given the significant growth potential as the company embarks on its westward expansion across the U.S.
Right now the Dunkin’ Donuts restaurant brand is prolific throughout New England, where it has one store for every 8,200 residents. But move west and that store count drops quickly.
In fact, once you get near the middle of the country, the restaurant is basically non-existent, with only one store for every 500,000 people.
As a result, every state west of New England represents a large growth market for Dunkin’ Brands. And it’s going after that opportunity, with plans to double its U.S. store count from 8,062 to over 17,000 within the next 20 years.
In 2014 alone the company opened 422 new stores, more than a 5% increase. And it plans to open another 410 to 450 in the U.S. in 2015. It is steadily announcing store opening plans, with the latest press release hitting the wires yesterday. This one announced agreements with seven franchise groups to develop 51 restaurants in Virginia and West Virginia over the next several years.
This westward expansion is the single most important growth driver, since it powers both top and bottom line results while creating a leveraged growth impact if same-store sales (SSS) also increase.
This SSS growth figure is a key figure to watch, since it signals that growth is picking up for Dunkin’–  something that wasn’t the case last year.
In 2014, domestic SSS growth came in at just 1.6% on 4.9% total revenue growth. That was a deceleration from SSS growth in the U.S. of 3.4% in 2013 on 8.5% total revenue growth.
But over the next two years I expect U.S. SSS growth will rebound to around 2.5%, or more. Consumers are doing much better than they have in years. Incomes are up, unemployment is down and lower gas prices mean more expendable income. Dunkin’ is also rolling out a perks program that should help bump loyalty up a little more.
Add in the impact of new store growth, which is trending at around 5% annually here in the U.S., and one can see why annual revenue growth of 5% to 7% over the next two years is entirely reasonable.
There is also considerable growth potential from overseas markets, even though these markets aren’t exactly inspiring confidence at the moment. But still, around 20% of the company’s sales come from restaurants located in over 40 countries around the globe.
The international opportunity is huge for Dunkin’ Brands. The company’s global footprint grew significantly in 2014, as it opened 282 net new stores outside of the U.S. And international SSS growth was 5% last year.
It plans to open an additional 200 to 300 stores in 2015 across overseas markets. However, the biggest international plans will happen after 2015. Dunkin’ has agreed with a franchisee to open and operate over 1,400 stores in China within the next 20 years. And it also announced plans to open over 100 stores in Mexico.
While the international opportunity is sizeable, it’s still the U.S. market that I’m most excited about, especially for the Dunkin’ Donuts brand.
Dunkin’ Donuts is a well-known brand in the Northeast, where there is one store for every 8,200 residents. From where I sit right now, I have a choice of four locations that I can be at in five minutes to get my next iced coffee.
In 10 years, that’s likely to be more common east of the Mississippi. And in 20 years, Dunkin’ locations could be ubitquitous perhaps all the way to the West Coast.
Dunkin’ is also interesting because its business model is somewhat different from most in its industry. While most quick-service restaurants employ a franchise business model, Dunkin’ has taken the concept further – virtually all of its restaurants are owned by franchisees. It only owns 36 of the company’s 18,000 stores around the world.
The company earns regular income from franchisees in the form of royalties, franchise fees and rent. This model helps insulate the company from fluctuations in most raw materials costs (the exception being dairy products) since royalties are based on gross sales, not profit.
The company’s almost 100% reliance on franchisees will help advance its expansion plans with much lower capital costs than many competitors. Franchisees fund the majority of new restaurant development, as well as the majority of advertising costs.
This business model means Dunkin’ has industry leading gross margins of over 80%, versus 38% for McDonald’s (NYSE: MCD) and 27% for Yum! Brands (NYSE: YUM). It also means the stock tends to trade at a higher multiple then non-franchised growth peers, which is why the current forward P/E of 24.7 isn’t a red flag for me. It’s not uncommon to see these types of stocks trade up to 28 times forward earnings.
Because of the company’s strong cash flow, Dunkin’ Brands has been able to grow its dividend, even while buying back shares. Management increased the quarterly dividend from $0.19 to $0.23 in 2014. And after reporting 2014 year-end results it bumped it up another 15% to $0.265. At today’s price, the stock yields just under 2%.
This isn’t a company that is going to have a sales explosion overnight – instead it is a very steady and consistent grower that growth investors can buy and hold on to for the long term. The company has a great brand with tremendous loyalty and recognition in the Northeast, though much of my investment thesis lies in management’s ability to expand westward.
Other initiatives to grow same-store sales, like offering coffee in K-cups, expanding the menu (breakfast sandwiches), a new loyalty program and adding nontraditional stores such as in airports, college campuses and train stations, could add incremental growth.
I think it’s a great stock to own for the long haul. With a market cap of just over $5 billion and a 2% dividend there is a lot of room for both capital gains and dividend income before the company reaches a stalling point.
This is a stock that I recommended to subscribers of my growth stock advisory service, Top Stock Insights, this spring. So far the idea has worked out well,.We’re up 17% and the stock continues to trend in the right direction. Though it’s priced a little high to buy right now, I’m thinking that this market downturn could bring the stock back down toward $50 and give new investors a nice entry point to play a durable U.S. consumer growth story.
I think a fair price target is around $60. But as with most great growth stocks, that price target is likely to be revised up and up and up as time marches on, the expansion marches west, and Dunkin’ shows that the growth trend is intact.

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