Investing in Dunkin’ Brands: Relative valuation and your dividend

The coffee industry is difficult to understand in terms of the relative valuation. Industry stock prices per share range from 46.0x to 15.4x earnings per share, with the average at 26.4 times earnings. This means that investors have historically been willing to pay a sizable premium for future earnings of certain companies within the industry. The range of market values and enterprise values within this industry are very wide. Frankly, enterprise value is a poor metric to use to compare the sizes of companies within this industry because it assumes the debt structures are all similar. This is not the case. There’s an example of this below, where Dunkin’ Brands Group has over five times more total debt compared to total equity versus the industry average of 1.17 times more debt to equity.

Dunkin’ Brands has the highest industry return on equity. This is no surprise, considering the company’s capital structure, which highly favors debt as a source of funding. At first glance, you might take this to mean the company is efficiently using this debt to generate returns for investors. However, the strongest portion of the industry isn’t that far off. McDonald’s and Starbucks boast returns on equity over 30%, with significantly less debt. Frankly, the IPO is what left McDonald’s with excess debt. Now, the company’s relying on organic growth to offset the risks associated with this debt acquisition.

Recently, Dunkin’ Brands’ stock price has underperformed Starbucks and the rest of the industry average. Of the companies that pay dividends within this industry (DNKN, SBUX, MCD, and THI), Dunkin’ Brands’ dividend yield is very close to the industry average of 1.33%, with plans to increase the dividend for investors in the near term. Competitors’ dividend yields range between 1.35% and 3.40% for Starbucks and McDonald’s, respectively. This industry isn’t the right fit for an investor with an appetite for steady income streams as opposed to the prospect of organic growth.

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