Dunkin’ Brands offers investors one of the more compelling domestic and international growth stories in consumer cyclicals with an exceptionally strong free cash flow profile.  Dunkin’ can extend its brand reach beyond its core markets, as management has improved franchisee cash-on-cash returns in more nascent Western and Midwest markets through better site selection, national advertising, higher-margin products, and flat national pricing for raw materials.

Many think several aspects driving franchisee returns in the United States can be applied overseas, which should attract new franchise partners and provide a long runway for global growth. Franchisees own virtually all Dunkin’ Donuts and Baskin-Robbins locations, providing an annuitylike stream of royalties with few corresponding capital needs. The stability of this revenue stream, coupled with strong unit growth prospects, limited commodity cost exposure, and supply chain improvements, could drive 1,000 basis points of adjusted operating margin expansion over the next 10 years.

Dunkin’s strong free cash flow generation and lack of near-term debt maturities should also provide a lift to total shareholder returns through dividend increases and share repurchases. Despite the optimism for Dunkin’s asset-light business model and longer-term growth potential, some believe the market has priced in unrealistic assumptions.

As with most restaurant chains, we view the pace of new restaurant openings as the most crucial variable in our fair value assumptions. Based on consumers’ acceptance of the brand, current market saturation rates, franchisees’ access to capital, and commercial real estate availability for specialty coffee concepts, we believe Dunkin’ Donuts has ample opportunity to expand in the U.S.–particularly outside the brand’s core Northeast markets. Based on a customer reach per restaurant goal of almost 20,000 to 1 in the U.S. (compared with 9,300 to 1 in its core Northeastern markets), we ultimately agree with management’s target of 15,000 Dunkin’ Donuts U.S. locations over the next 20 years, with much of the growth coming from franchisees in the U.S. Southeast, Midwest, and West.

We believe Dunkin’ Donuts U.S. can add more than 4,000 franchise locations in the U.S. over the next decade, suggesting 11,300 locations by the end of 2022 (implying approximately 450 net new units annually), with another 4,000 units coming in subsequent years. Additionally, we believe both Dunkin’ Donuts and Baskin-Robbins have significant growth opportunities outside the U.S. With an established foothold of approximately 7,700 restaurants outside the U.S. (roughly 3,200 Dunkin’ Donuts and 4,500 Baskin-Robbins), Dunkin’ appears to be among the handful of Western quick-service restaurant chains with the potential for at least mid- to high-single-digit international unit growth over the next 10 years.