Time To Make The Donut Stocks? Dunkin’ IPO Heads Hot Coffee Sector

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Commuters stopping by Dunkin’ Donuts (DNKN) tomorrow morning may want to add 100 shares of DNKN to their bear claw order.

Twenty-four hours into its life as a publicly traded company, the Dunkin’ initial public offering has been a big hit with investors. The stock jumped 47% on its first day of trading, up from its initial list price of $19 per share to $27.85 per share.

Of course, investors have been down this donut hole before – in 2000, Krispy Kreme (KKD) stock flew off the shelves, rising 76% on its first day of trading. Today, Krispy Kreme is a case study in how not to grow a franchise – and is currently trading at only about $8 per share.

Why do investors think Dunkin’ can brew a different story? Here are a few reasons that seem to be bobbing around:

Bullish expansion model – Krispy Kreme tripped up on several fronts, but one of the biggest was its plan to expand too quickly. But that didn’t pan out. Dunkin’ already has its admittedly aggressive expansion model well in place, and its emphasis on coffee over donuts has proven reliable. The company already has 6,800 shops operating in 36 states and plans to have 15,000 franchises up and running over the long term.

Good financial practices – To stabilize things further, Dunkin plans to use its IPO cash (it expects to garner about $423 million on 22 million shares of common stock) to pay down debt, a sound move in a market where investors are looking for any reason to head to the hills – and company debt is at the top of the list.

Franchise model works – Unlike most “fast food” operators, it’s the store owners who take on most of the risk – not Dunkin’ management. Franchise owners pay most of the up-front costs to run a Dunkin’ Donuts or Baskin-Robbins outlet, and they pay most of the costs for commodity purchases, leaving management – and investors – largely insulated from jumpy commodity markets.

Coffee is king – Above all, it’s the coffee model, and not the donut model, that investors believe sets Dunkin’ up for long-term growth. Beverage sales comprise over 60% of company sales. And right now, big chain coffee shops still resonate with consumers and investors. Cases in point: Despite rising commodity prices, Starbucks (SBUX), and Green Mountain Coffee Roasters (GMCR) are still widely considered good growth stocks and have managed to hold up well by doing the once unthinkable – passing on rising commodity prices to customers.

Dunkin’ Donuts is the blue-collar version of Starbucks, and value-aware customers know that. In a hot retail coffee market, Dunkin’ is a lower-cost option for the in-and-out coffee and cruller crowd. That’s not a bad place to be in today’s sluggish economy.

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