3 Reasons To Be Cautious About Investing In Dunkin' Brands


Photo: Flickr/Rene Schwietzke

People ask me all the time which franchise I would be most likely to invest in. After the hundreds of annual franchise reports I have read through, the countless interviews I have done with franchisors and franchisees, and all of the advice I have gained from industry experts, I say Dunkin’ doughnuts – without hesitation.  Dunkin’ Brands, the owner of Dunkin doughnuts and Baskin Robbins, was founded in 1950 in Quincy, Massachusetts and was primarily focused on doughnuts. But their foray into coffee (now 60% of sales) has led to significant growth, financial return, and an attack on Starbucks’ position as the coffee king.  Given Dunkin’ Brands’ return-hungry private equity owners, Bain Capital, The Carlyle Group and Thomas H. Lee Partners, it was only a matter of time before the company went public.  But as more information has come to light with the recent Initial Public Offering (IPO), a number of financial and business issues have emerged that are alarming.

The primary use of proceeds from the IPO is going to pay down debt. However, Dunkin’ Brands will continue to have a highly leveraged capital structure (i.e., spending their cash to pay interest expense) and following the equity offering, Dunkin’ Brands will have to be very cautious with its use of future cash. The plan is to grow Dunkin’ doughnuts west of the Mississippi through franchisee expansion. But Dunkin’ Brands has tried this in the past with miserable results. And although Dunkin’ doughnuts is known and seen at just about every street corner on the East Coast, the Company lacks this strong brand recognition elsewhere.

Here are 3 reasons why investors should be cautious about investing in Dunkin’ Brands:

1)  Baskin Robbins: Let’s face it. We like the 31 flavours but Baskin Robbins has been holding Dunkin’ doughnuts back. With average store sales just over $295,000 in 2010, most franchisees can barely stay afloat. Dunkin’ Brands has failed to revive this concept and unfortunately, I think we will continue to see more Baskin Robbins stores close.

2)  Dunkin’ doughnuts Growth Beyond the East Coast: The concept is stellar. When coffee is 60% of your sales and you are generating the volumes that Dunkin’ doughnuts is (average store in New England generates just under $1.0mm in sales), it really is a no-brainer. But, in the Midwest, the average store generates $600,000 in sales (40% lower than the northeast). This is certainly a cause for concern for new franchisees entering the system since there is little room for expansion on the East Coast. It’s also a concern for stock investors because without new expansion, Dunkin’ Brands’ management will not meet growth goals.

3) Legal Battles: In 2010 alone, 15 lawsuits were brought forth against Dunkin’ doughnuts franchisees. McDonald’s, the biggest franchise in the world, had 6. This is troubling for both investors and franchisees. As a stock investor, do you want to be involved in a brand where franchisees are unhappy? See Quiznos for the worst case scenario.

We can say with certainty that Dunkin’ Brands is a well-oiled operation. Franchisees that joined the brand in the 80s and 90s have made a significant amount of money. But now that build-out costs are higher than 20 years ago, the average return on investment is much lower. Not to mention that franchisee gross profit continues to move downwards. It would scare me if investors turned a blind eye to what is really going on.

Having the luxury of being on the ground, I can see the frustrations of many franchisees and the long legal battles they have endured to separate from Dunkin’ Brands. Dunkin’ Brands, in the franchise community, is known for its questionable legal practices and coercive behaviour, which has been documented in “Dunk’D: A True Story of How Big Money is Corrupting the Franchising Industry.” 

While I like the concept and believe the equity markets are white-hot, I question Dunkin’ Brands’ management team.  Are internal practices in place to create an equitable environment?  Can the company execute on its ambition to expand westward? It was mentioned during the road show that the Company is considering using frozen doughnuts versus freshly made baked goods for some of their new markets. Is that what you want to buy on your next visit or sell to your newest customer?

NOW WATCH: Ideas videos

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.