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Is Dunkin' Brands piping hot or cooling off?

By Jonathan Chen
Benzinga Staff Writer / September 6, 2011

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There were a slew of research reports this morning on Dunkin' Brands (NASDAQ: DNKN), as today was the day research firms could initiate coverage on the coffee and doughnut shop. The most glaring report this morning came from Goldman Sachs, one of the underwriters of the IPO.

Why do you ask? Goldman initiated with a Sell rating. You very rarely see an underwriter initiate with a Sell rating.

In the report, Goldman said, "We initiate coverage of DNKN with a Sell rating and $23 target, implying 15% downside, versus our Restaurant coverage group's average 6% upside. We like DNKN's growth potential in the US and internationally, its margins are best in class, and there is the potential for capital allocation to boost shareholder returns. However, even after incorporating these opportunities, we do not expect the long-term EPS growth algorithm to exceed the mid-teens (in line with mature companies such as MCD (NYSE: MCD [FREE Stock Trend Analysis])/YUM (NYSE: YUM), yet the shares reflect faster growth. DNKN shares are up 65% from the initial $16-18 IPO range, and now trade ahead of fair value, in our view."

Goldman acknowledges the growth catalysts that Dunkin' has in front of it, such as high gross margins, growth potential outside the Northeast, as well as internationally, but has a $23 price target on the name. That is approximately $3 below where shares are currently sitting as of the time of this article.

You would think the underwriter on the IPO has more knowledge of the company, compared to other research firms which did not participate in the firms IPO. That is why Goldman's call may carry more weight then others. Plenty of other research firms were more bullish then Goldman, as none of them had an outright Sell rating on shares.

J.P. Morgan came out Overweight rating and a $30 price target on the name, as did Williams Capital. Stifel Nicolaus had a Buy rating and a $33 price target. Bank of America has a Neutral rating and a $29 price target. Wells Fargo has a Neutral rating.

Notice something here? Every bank has a much higher price target than Goldman does, yet they all see the same metrics. It always amazes me that seven research firms can see and analyze the same information, yet come up with various different conclusions. What is even more incredible is that the underwriter (in this case, Goldman), is the only bearish name on the company. When Dunkin' went public, the coffee sector was running like crazy. Valuations may have started to get stretched, and the market pullback reflected that. Yet, for an underwriter to slap a Sell rating on a company speaks volumes.

It very rarely happens, and when it does, the underwriter tends to be right more often then they are wrong. This is not to say that Dunkin' shares are going to drop to or below the Goldman price target anytime soon. If macro economic conditions improve, and the company is able to grow faster than expected, then Goldman's price target could be wrong.

Traders may want to heed the advice of Goldman, at least for now, as shares could be overheated. Dunkin' is one pot of coffee that looks like it may be too hot at current levels. We all know Wall Street is just like Goldilocks. It does not like things too hot or too cold, but just right.

Wall Street may not be running on Dunkin', but America sure does.



Traders who believe that Goldman is wrong, and that Dunkin' is not overvalued might want to consider the following trades:

DNKN shares have come well off their highs, which were $31.94. If the company can outperform what Goldman expects and reach the average target price of the 10 research firms, (around $29), it could be a good trade at these levels.


Traders who believe that Goldman is right may consider alternate positions:

Dunkin' still has a ton of debt from when it went private last decade. If the debt servicing costs affect the company's growth prospects, a $23 price target could be optimistic.

Neither Benzinga nor its staff recommend that you buy, sell, or hold any security. We do not offer investment advice, personalized or otherwise. Benzinga recommends that you conduct your own due diligence and consult a certified financial professional for personalized advice about your financial situation.