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Wednesday, July 27, 2011

DUNKIN COFFEE SALES COULD HURT MCDONALDS AND STARBUCKS

Story first appeared on WSJ.com.
Dunkin' Donuts runs on coffee, not doughnuts. As parent Dunkin' Brands prepares to go public and expand beyond its Northeastern roots, expect the coffee wars to heat up.
On Tuesday evening, the initial public offering of Dunkin’Brands Group Inc. was priced at $19 a share, raising $427.5 million. The franchise-centric company, which houses both the Dunkin' Donuts and Baskin-Robbins chains, plans to use the funds to pay down debt and move beyond its Northeastern roots. Though Dunkin' doesn't have the same level of brand recognition as McDonald's or Starbucks Corp., the company also hasn't penetrated the western U.S. or other parts of the country as deeply, giving it more opportunity to expand. And it's there that it hopes to give both rivals a run for their money among caffeine cravers.
Dunkin' Brands is owned by private-equity firms Bain Capital Partners LLC, Carlyle Group and Thomas H. Lee Partners, which bought it in 2006 for $2.4 billion. They will maintain a controlling interest; about 20% of the shares outstanding are being floated.
Like many companies in private-equity hands, Dunkin' carries a hefty debt load. In the first quarter, 75% of Dunkin's operating earnings were wiped away by interest payments. The load was made heavier after owners in November borrowed more to pay themselves a $500 million dividend. Even post-IPO, Dunkin' will carry about $1.5 billion of debt, according to the prospectus. But it also has more flexibility to expand since all of its stores are franchises.
A company once known for its commercials showcasing a sleepy baker waking up to make fresh doughnuts now advertises its coffee with "America Runs on Dunkin'" and "What Are You Drinkin'?" slogans. Its orange-and-pink signs feature a coffee cup next to its name. It sells more servings of hot regular coffee and iced coffee than any other fast-food chain in the U.S., including Starbucks, according to NPD market research data. In New England and New York, Dunkin' says it has 57% of the fast-food coffee market. Coffee and other drinks represent 60% of the Dunkin' Donuts chain's U.S. sales, according to the prospectus.
At McDonald's, which kicked off the coffee war three years ago when it began rolling out specialty coffees nationwide, about 6% of U.S. revenue now comes from coffee drinks.
Starbucks could lose customers to Dunkin' Donuts, but competition is likely to be more fierce between Dunkin' and McDonald's due to the two chains' similar pricing. As Dunkin' expands into more of McDonald's territory, the two chains are likely to engage in price wars. Stepped-up competition also may force Dunkin' to expand its menu beyond breakfast, the way Starbucks recently has with snacks and "bistro boxes" containing lunch items.
Dunkin' Donuts is a munchkin next to McDonald's, which has more than 14,000 restaurants in the U.S. and had $24 billion in 2010 revenue. By comparison, Dunkin Donuts products are sold in 6,800 locations in the U.S., including supermarkets as well as its coffee shops, and Dunkin' Brands' 2010 revenue totaled $577 million.
The doughnut chain plans to open as many as 250 more shops in the U.S. in the next two years. The company says in its prospectus that its expansion strategy has the potential, over approximately the next 20 years, to more than double their current U.S. footprint and reach a total of 15,000 points of distribution in the U.S., including grocery stores.
A Dunkin' spokeswoman declined to comment, citing a pre-IPO quiet period.
The Dunkin IPO is one of the most anticipated offerings of 2011. Dunkin' Donuts demonstrated the strength of its business model when it suffered only modest sales declines during the recession and recovered in 2010 with growth of 2.3%.
Dunkin' boasts in its prospectus that it had 45 consecutive quarters of positive comparable store-sales growth until the economic meltdown pulled it into negative territory in 2008 and 2009. Though same-store sales are in positive territory now, the level is below 3%—half the level seen in 2004 and 2005.
Its same-store sales growth also is lower than the 7% seen last year at Starbucks, which was hit harder in the recession and has fought to come back by closing under-performing stores, boosting the perks of its loyalty-card program and introducing new varieties of its Via instant coffee.