RBC: Dunkin' Donuts' 'dramatic reduction in menu items' will make it a lot more profitable

Shares of Dunkin' Brands, the parent company behind Dunkin' Donuts and Baskin-Robbins Ice Cream are higher by almost 2% on Monday after receiving an upgrade from RBC Capital Markets.

RBC analyst David Palmer upgraded shares to "Outperform" from a "Sector Perform" and raised his price target on the stock from $54 to $64, implying an upside of 12.5%.

"We believe the company is taking steps to improve franchisee profitability and core customer satisfaction," Palmer wrote. "In our view, this will ultimately stabilize and potentially reaccelerate franchised revenue growth. In addition, we believe improving growth and the opportunity for significant cash back to shareholders can help Dunkin' close its valuation gap to peers."

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Shares of Dunkin' tumbled by about 30% in mid-2015 as Dunkin' failed to keep up with growing competition in the coffee space from competitors such as McDonald's and 7-Eleven. Since 2016, shares have bounced back as Dunkin' has experimented with its menu and more urgently battled back against the competition.

Dunkin' is in the process of cutting back its menu choices by up to one-third. Palmer thinks this is a good thing, writing, "We believe a dramatic reduction in menu items and heightened focus on the core coffee franchisee could bolster franchisee profitability by as much as 'hundreds of basis points' over the next year."

Palmer thinks that the return to a coffee-focused strategy will be headlined by the release of frozen Dunkin' coffee drinks this summer.

Additionally, Palmer said RBC is excited about Dunkin's entry into the $2.3 billion ready-to-drink coffee market. Now, consumers can buy cold, bottled Dunkin Donuts coffee in corner stores, gas stations, and grocery stores across the country.

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Dunkin' currently trades at 16 times 2017 EV/EBITDA, well below the industry average of mid to high 20x. The EV/EBITDA is a ratio of a company's enterprise value (market capitalization and preferred shares and debt, minus total cash) to its earnings. While Palmer said this is because of Dunkin's slowing growth, the analyst said that there is plenty of room for multiple expansion if Dunkin' can get their turnaround going at full speed.

Click here for a real-time Dunkin' Brands Group chart.

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