A Lukewarm Beginning at Dunkin' Donuts (DNKN, SBUX, MCD, YUM, PBJ)

It looked like Dunkin’ Brands Group, Inc. (NASDAQ: DNKN) was off to a great start following its IPO last week. Shares soared 50% from the offering price as investors piled in. But a stellar earnings report from Starbucks Corp. (NASDAQ: SBUX) soon cooled the coffee, so to speak.

Dunkin’, parent of Dunkin’ Donuts and Baskin-Robbins, reported adjusted net income for the second quarter of $24.7 million, a drop of -3.3% from the same period a year ago. Revenue rose 4.4%, from $150.4 million to $157 million. McDonald’s Corp. (NYSE: MCD) reported second quarter earnings about a week before Dunkin’s IPO and handily beat estimates. Yum! Brands, Inc. (NYSE: YUM), too, beat estimates and raised guidance as well. Dunkin’ is going to have to go some to compete in this sector.

One of the more interesting observations about the fast food sector is that each of the big players achieved its recent success in a different way. Starbucks closed hundreds of stores and fired 12,000 workers. McDonald’s grew same-store sales in all its regions in the second quarter with revenue and operating profit both growing strongly. Yum relies on diversity much more than does McDonald’s, with Pizza Hut, KFC, and Taco Bell brands developing at different paces in different places.

Dunkin’ noted in its earnings report that it was focusing on driving same-store sales, expanding in the US, and seeking faster growth internationally for both its brands. Dunkin’ appears to be trying to achieve growth using both McDonald’s- and Yum-like approaches. The company reported 3.2% same-store sales growth in the US, led by the Dunkin’ Donuts brand. The company is also expanding globally, having added 343 Dunkin’ stores and 251 Baskin-Robbins stores in the past 12 months.

The strategy appears to be to throw as much as Dunkin’ can at the wall and see what sticks. Trying to follow in the footsteps of both McDonald’s and Yum will inevitably lead to a reaction from both. Dunkin’ may not be in a position to stand up to that kind of warfare.

McDonald’s, for example, holds cash and equivalents that are 10 times as large as Dunkin’s. If the golden arches decide to eat cost increases in an effort to keep prices low, Dunkin’ can’t really fight that battle. Likewise, Yum, with its international breadth, can take pretty precise aim at Dunkin’ if the larger company feels threatened in any market.

Dunkin’ holds on to long-term debt of $1.85 billion, a lot for a company with a net cash flow from operations of just $38.5 million. If the company tries to float more debt, which is not unlikely, the share price could take a real beating.

Dunkin’s shares are down nearly -4.5% in early trading today, at $26.56, in a range of $24.97-$31.94. Volume has been fairly light, though, compared with the average volume of 12 million shares traded in the first few days of trading. McDonald’s shares are up fractionally, while both Starbucks and Yum Brands shares are trading down slightly. The PowerShares Dynamic Food & Beverage ETF (NYSE: PBJ) is down about -1% as well, at $18.99, in a 52-week range of $15.15-$20.60.

Paul Ausick