Coffee has long been the beverage of choice in many parts of the world, and the US has joined the coffee craze with gusto. Although Americans don’t tend to like it quite as strong as it is served in Spain, Italy, France and throughout Central and South America; the continued strong performance of such giant coffee chains Starbucks (SBUX, Financial) and Dunkin’ Donuts (DNKN, Financial) makes an investment in coffee something worth considering. After all, America Runs on Dunkin, as the slogan says. But which of the major coffee chains makes for the best long-term investment?
Setting the stage: The price of the bean
After its last peak in May 2011, coffee prices have been declining sharply ever since, down 55%. Many of the big coffee companies have slashed their prices, passing the savings on to consumers. But not Starbucks. In fact, the upscale coffee retailer actually increased prices throughout 2011 and 2012 in most locations around the country. The company’s strategy of resisting price cutting is smart. If people are willing to pay extra for the Starbucks magic, then so be it.
The results for the company, and therefore its shareholders, have been great – Starbucks posted its most profitable quarter ever at the end of 2012, and its second quarter earnings beat analyst estimates by a decent margin. However, it’s a tricky strategy to know how far you can go keeping prices at elevated levels when everyone else has been cutting. Starbucks will need to be careful not to alienate customers. On the upside, people who are devoted to Starbucks tend to be very loyal to the brand, regardless of the price they pay. If coffee prices have bottomed out, now is the time to invest in this coffee giant to anticipate rising prices.
Starbucks by the numbers
First, take a look at year-over-year increases in EPS. In December 2012 the increase was 14%. For its second quarter ended March 31 2013: an amazing 27.5%. By contrast, the first-quarter growth in EPS for Dunkin’ was a scant 4.75%. In addition, the Starbucks profit margins have marched steadily upwards over the last several years and now stand at just under 11%. Dunkin’ stands currently at 14.7%, but seems vulnerable to sharper ups and downs than the mermaid. And Starbucks is smart about setting up fixed-priced contracts for its beans, which means it’s keeping costs under control.
Taking a look at the balance sheet, Starbucks has been increasing its cash on hand, which now tops $2 billion, while at the same time managing to lower its debt, which has resulted in an increasingly favorable (lower) debt to equity ratio. For the quarter ended March 31 2013, Starbucks saw net income weigh in at $.51 per share, up from $.40/share the previous year. Same-store sales also increased by 6%, whereas growth for Dunkin’ in this same key retail metric was only 1.7%. Net income for Dunkin’ was actually down by 8.3% compared to the same quarter in the previous year.
Opportunities for growth
Dunkin’ continues to do well on this account, especially because of much room for growth as it heads West, not to mention going international. It could open as many as 700 or more stores. Revenues for Dunkin’ are expected to continue to grow at rates in the high single-digits for at least several more years. Starbucks, on the other hand, is expecting revenue growth in the double-digits.
Starbucks has also done well in its consumer packaged goods divisions with pre-packaged coffee products and its increasingly popular k-cups products, both of which have high margins than its in-store prepared beverages. These are important and diversified revenue streams for the company. The real opportunities for growth at Starbucks lie outside the continental US, which could see the company opening more than 1,300 locations, including 600 in Asia, with more than half of those slated for China.
Why does Starbucks do so well?
People buy coffee from Starbucks because it is very high in quality and offers a total coffee experience, from the Wi-Fi to the comfy chairs and couches to mobile phone apps that help you make the most of its rewards program. By contrast, people go to Dunkin’ Donuts for coffee because it’s cheap, not because they’re looking for a total coffee experience.
Starbucks and Dunkin’ aren’t the only names in town, either. Keurig Green Mountain has been doing well, with strong appreciation in its share price (up 70%+ year to date) due to substantial increases in its EPS (nearly 30%). Tim Horton’s is a café company that’s been expanding from Canada into the US and seeing solid growth in revenues (mid-single-digits) , same store sales (low-to-mid single-digits) and a dividend hike to boot (20% increase). The J.M. Smucker is another player in this industry, which currently gets more than half of its total revenue from the sales of coffee, and pays a decent dividend yield of 2.2%. Still, with a market cap close to $50 billion, all of these companies are dwarfs compared to Starbucks.
The bottom line
Starbucks is at the higher end of its valuation range, so it’s hard to say how much share prices might appreciate, but just going by its historical performance, which the current number support, the stock could easily rise from its current $60s to well over $100. Even if it doesn’t appreciate that much, it is paying solid dividends, with room for growth there as well. Investors who merely reap the returns from dividends could do better than 4.5% over the next couple of years and possibly be pleasantly surprised by gains in share price as well. The bottom line is that if you’re looking to inject a bit of caffeine into your portfolio, Starbucks is the clear choice.
