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JP Morgan Downgrades Dunkin Brands: How to Trade It

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Analysts at JP Morgan (NYSE: JPM) downgraded shares of Dunkin' Brands (NASDAQ: DNKN) from Overweight to Neutral on Tuesday morning. In late trading, Dunkin shares were trading down around 2.40% to $34.50. The analysts wrote "After a period of restrictions, we are refreshing our view on DNKN shares. Reflective of extremely strong outperformance, we are downgrading Dunkin' Brands to Neutral. The stock is up ~90% since the pricing of its IPO in July 2011, up ~45% YTD, and is just 4% off its recent high, in contrast to peers McDonald's (NYSE: MCD), Chipotle (NYSE: CMG), Domino's Pizza (NYSE: DPZ), Yum! Brands (NYSE: YUM), and Starbucks (NASDAQ: SBUX), which are down 10-15% from their 52-week highs."

JP Morgan also had some additional commentary on Dunkin Brands' competitor Starbucks. The analysts said in a separate report that Starbucks (NASDAQ: SBUX) remains one of their top global picks in quick-service restaurants. The top pick right now is Yum! Brands (NYSE: YUM) in the sector, with the least favorite of the three stocks being McDonald's (NYSE: MCD). Nevertheless, JP Morgan has an Overweight rating on McDonald's, but currently prefers Yum! and then Starbucks in its Buy-rated quick service restaurant universe.

On Starbucks, the analysts wrote that "we continue to believe in high visibility in this stock, but weaker Europe is matched with what we believe is an unavoidable slowing in the recently strong China comp trends." If JP Morgan's read of the sector is correct, a pair trade could be setting up in Dunkin' Brands and Starbucks. The two stocks have been fairly correlated in 2012, but the divergence in their returns has widened in recent months.

Year-to-date, Starbucks shares are up around 17% while Dunkin has climbed almost 39%. Most of Dunkin's outperformance has occurred in recent months, and investors may want to consider shorting Dunkin while going long Starbucks. Consider that Dunkin shares are up roughly 12% over the last 3 months while Starbucks has lost more than 8%.

In the near-term, this divergence is beginning to close with Dunkin falling 0.40 percent over the last month while Starbucks rose roughly 2.50 percent. If JP Morgan's call is correct, this near-term trend may continue and the divergence between Dunkin and Starbucks' returns in 2012 may continue to close. In other words, look for Starbucks to outperform Dunkin going forward.

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