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Dunkin’ Brands Group (DNKN: Nasdaq)

By Maxim Group ($43.45, Feb. 22, 2016)

We are maintaining our Buy rating and $54 price target on Dunkin’ Brands Group following the announcement from Starbucks that it would be changing its My Starbucks Rewards from a transaction-based program to a dollar-based program.

In light of the higher dollar threshold for Starbucks’s (ticker: SBUX ) program (relative to that of Dunkin’ Brands ( DNKN ), we believe that customers with a lower average dollar spend will shift visits to Dunkin’ Brands, which we argue has a more generous rewards program.

Starbucks announced key changes to its My Starbucks Rewards program that benefits high-dollar customers, but provides less of a benefit for low-dollar spenders. Under the current My Starbucks Rewards program, customers are awarded one star for each transaction, such that they are awarded a free beverage after 12 stars and “gold star” status after 30 stars. The revamped program, which will be launched in the U.S., Canada, and Puerto Rico in April, will award two stars for each dollar spent, regardless of the number of transactions. Gold-star status will be reached at 30 stars ($15 spent), and upon reaching this status, customers will need to earn 125 stars ($62.50 spent) in order to receive the first beverage reward.

Although we agree with Starbucks management that the revamped program will speed transaction times and increase spending among high-dollar value customers, we believe that customers with smaller-dollar transactions will be at a disadvantage under the revamped Starbucks program. Specifically, only those customers spending more than $5 per transaction would be at an advantage, according to our model.

In our view, Dunkin’ Brands’ DDPerks program is a more attractive rewards program than the revamped Starbucks program. The DDPerks program awards five points for every dollar spent. Rather than waiting to attain a certain status, DDPerks customers receive a free beverage immediately upon signup, and only have to earn 200 points ($40) to earn a free beverage. Given the lower dollar threshold for the DDPerks program, we believe that some Starbucks customers—particularly lower-dollar transaction customers—may shift their ordering preferences to Dunkin’ Brands in the next few quarters.

According to our model, the average Starbucks customer who spends $2.19 for a medium coffee (based on the average price in the Northeast U.S. markets where both Dunkin’ Brands and Starbucks compete) will need to make 29 visits before earning a reward, while the average Dunkin’ Brands customer who spends $2.00 for a medium coffee will need to make only 20 visits before earning a similar reward.

In addition to the more-attractive rewards offered by DD Perks, we believe that another potential catalyst offered by DD Perks will be the rollout of mobile payments, which we contend will help boost transaction growth. We estimate that the combination of mobile payments through DD Perks and potential customer defections from Starbucks will add about 50 basis points-75 basis points to comp growth in 2016 (half of which we expect will come from Starbucks defections alone).

We contend Dunkin’ Brands’s valuation remains attractive, even after the recent rebound. Our outlook for earnings-per-share growth average about 15% through 2017 is predicated on: 1) a return to long-term comp growth of about 3% at Dunkin’ U.S, helped in part by what we believe will be a system-wide mobile ordering launch in the second half; 2) a solid new unit pipeline world-wide; 3) steady-to-lower commodity costs; and 4) opportunistic share buybacks. Equally weighting the forward price/earnings multiple (based on a 21 times multiple, which yields a $52.90 price target), forward enterprise value/earnings before interest, taxes, depreciation and amortization (EV/Ebitda) multiple (based on a 15 times multiple, which yields a $54.00 price target), and sum-of-parts (which yields a $54.76 price target) methodologies, and using a base valuation year of 2017 estimates, we arrive at our unchanged $54 price target.

-- Stephen Anderson

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