Dunkin' Brands Path to Coffee Dominance Just Got Steeper

Dunkin' Brands (NASDAQ:DNKN) has ambitious long-term hopes to break out of its current regional footprint, surge westward across the country, and double its stores in the U.S. Many of the company's recent initiatives, including an upgraded snack menu and the relaunch of an espresso-based beverage platform, have been aimed at supporting that strategy.

Yet the coffee and snack giant's latest earnings report hinted at the limits of the power of those moves, especially as companies like Starbucks (NASDAQ:SBUX) and McDonald's fight over the same subset of caffeine- and calorie-seeking customers.

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A tough competitive environment

Dunkin' Brands said in its fourth-quarter report that sales growth was nonexistent at established locations, marking a slowdown from the modestly positive upticks the chain posted in each of the last two quarters. That's a disappointment considering Starbucks and McDonald's both grew sales by 4% in the U.S. for the period.

Like these national giants, Dunkin' Brands cited lower customer traffic as a drag on growth. The difference is that its peers found ways to boost average spending per customer visit. Starbucks in particular noted improving traffic and spending trends, which suggests Dunkin' Brands' move into premium beverages failed to poach market share from the industry leader. 

That drink launch did support rising profitability, though, as the espresso-based beverage platform helped push operating income up to $102 million, or 32% of sales, from $96 million, or 30% of sales, last year. There are no glaring problems with Dunkin' Brands' efficient operating model, as profitability inched higher for the full year.

Overall, executives sounded an optimistic tone despite the tough selling conditions in the industry. "While we did not drive consistent traffic momentum," CEO David Hoffmann said in a press release, "we laid the foundation for future growth" through improvements to the menu and aggressive store remodeling spending.

Expanding slowly

Dunkin' Brands issued a new medium-term outlook that amounts to scaled-back growth expectations. Sales at existing locations are still projected to rise in the low single-digits, roughly on par with the past year's 1% uptick. Yet the company plans to open just between 200 and 250 new locations across the U.S. in each of the next three years, compared to 278 last year and 313 in 2017. The more immediate outlook is even weaker, with about 200 launches expected in 2019.

It makes sense for the chain to slow its footprint expansion while growth trends are declining at existing locations. The shift will free up cash that executives can direct toward improving established stores and building on recent wins in its snack and beverage offerings. Dunkin' Brands' more modest expansion also likely played a role in the 8% dividend increase management just announced.

At the same time, a third straight year of reduced store launches shows that the restaurant chain faces serious challenges in its bid to double its U.S. footprint to nearly 20,000 sales points. Dunkin' Brands still might eventually hit that target, but for now, the chain has to focus on recapturing customer traffic growth at its existing stores and finding a way to speed up sales gains to levels already enjoyed by its national peers.