DDIFO asked a restaurant stock analyst to review the recent S1 filed by Dunkin’ Brands.

Here are the highlights:

Operations and Stores Notes:

 

  • DNKN speaks to franchisee economics but does not outline them in any detail in the S1 or anywhere else.
  • They refer to a $220M supply chain cost containment number, which may reflect cost savings and cost containment generated or supplied by the NDCP.
  • DNKN notes 1000 DD’s may have on site bakery facilities but does not define that further or its implications.
  • DNKN seems to disclose US comparable sales only, which means it may have a data collection problem.
  • DNKN defines the afternoon/evening snack period as 12% of revenue; first I had ever seen an exact disclosure of these daypart sales.DNKN makes the point again about their lower per capita store penetration and thus sales and development potential in the “Western US”. Analytically, though, a multi analysis approach will show the dramatic sales falloff outside of the core northeastern markets, such that penetration ratios alone do not determine sales potential.

 

Personnel Notes:

  • Neil Yanofsky has joined DNKN as Senior Vice President of International in May. Yanofsky had long Panera and Au Bon Pain experience and extensive food background, but his international knowledge base seems limited.
  • Jon Luther continues as Non-Executive  Chairman of the Board, and receives a $50K annual salary for meetings, plus $1M in 2011, $500K in 2012 and  $250K in 2013, for board advisory services. Luther apparently is the beneficiary of $4.3M in senior management transition costs, as well.
  • Travis’s year 1 base salary is $861K, with short-term incentive and other compensation plans. He has $2.8M of his own funds invested, with much smaller amounts by the other Named Officers.
  • It is interesting that Kate Lavalle is still on board in a part time, non-executive role $100K/year). Perhaps she is the debt expert?

Financial, Debt and Leverage

  • DNKN’s total adjusted EBITDA as disclosed is $287.3M. This is the key debt and cash flow number to watch. This EBITDA percentage is 49.8% of total DBI revenue, the highest percentage margin in the significant, trackable restaurant universe—beating even runner up McDonald’s percentage at 35%, and way in front of SBUX, at 16%. Note that investors gravitate towards percentages over dollars, as an understandable metric at this will be part of the DNKN story going forward.
  • DNKN’s loan covenant’s (total debt to adjusted EBITDA,) is 8.6 X or less, and interest coverage ratio, 1.45 X or more. At end of Q1 2011, they were favorable to these covenants, at 6.3X and 2.2X. These ratios should improve after the first $400M from the IPO is received.
  • DNKN total debt is high, at $3.5 billion, which includes total debt, operating and capital lease obligations, one of the highest total debt values anywhere in the restaurant universe. To our research[2], this is the second highest company IPO debt dollar amount ever in the restaurant universe, with only YUM higher, at $5B, (then called Tricon) when it was spun off from Pepsico in 1997.
  • DNKN expects to pay no dividends, at least initially.
  • Interestingly, DNKN seems to run tight on cash, already $88M into their new revolver and just $120M in cash and equivalents on hand, as of March 26 2011.

Segment Profitability

 

  • Dunkin Donuts US is the vast bulk 78%, of the world-wide DNKN business segment  (EBITDA) profitability, $293.1M. DD International is an only drop in the bucket, at 4%, with. Baskin Robbins US EBITDA fell from 2009 to 2010 (and likely from 2008 levels as well). It is important to note that this segment reporting includes all business segments, company stores, franchise operations, real estate, licensing and other. Dunkin International shows up at a 103% margin.
  • Baskin franchising margins are much lower, at 53% US franchising margin and International at 46%.
  • Dunkin noted that it is operating 16 DD units, somewhere, in the US.
  • The DD US segment franchising margin is 72.8%. This is a high number but not as high as the worldwide franchising margin leader, McDonald’s.

Business Risks  Disclosed:

  • DBI discloses pretty much the expected business risks as one would imagine, but lists franchisees as risks 1 and 2: “DNKN financial results are affected by the operating results of the franchisees”, and “our franchisees could take actions that harm our business.”

Corporate Structure:

 

  • DNKN will be a controlled entity, governed by some but not all of the SEC regulations, since it is still minority outside ownership. The Board of Directors threshold is 10% for 2 board members, and 3% for one board seat. Only the Board Chair can call a non regularly scheduled board meeting.  
  • The 6% corporate employees/franchisees share purchase set aside is not apparently noted in the S-1.
  • DNKN has low bottom line GAAP earnings ($27M in 2010) but much higher EBITDA. While we know this IPO will target about $400M, the DNKN EV/EBITDA ratios suggest a total market capitalization of about $2.5 billion could be supported, eventually.[3] 
  •  DNKN peer group rivalry will likely become Tim Horton’s (THI), and McDonald’s to a lesser degree. THI had EPS of $3.58 in 2010, and an EBITDA margin of 37.7% in 2010, a relative powerhouse. THI had a better same store sales trend than did DD/BR and was positive even through the recession. And THI has a higher revenue base, $2.5 billion, versus DNKN of $577M.

[1]  Number of company stores, zero vs. 16, and amount of revolver debt outstanding, 0 versus $88M.

[2]  McDonald’s has more debt, $8 billion, but their IPO was in 1965.

[3]  An Enterprise value to EBITDA factor of 10 X is assumed. If DBI sells $400,000,000 in stock at a $20 per share rate that means that about 2 million share of stock will be outstanding.  Assuming DBI GAAP earnings of $27 million divided by 2,000,000 shares, that implies earnings per share of PE ratio of 13.5, right in the 10-20 historical range for restaurants.