Starbucks Versus McDonald's

Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When I think of Starbucks (NASDAQ: SBUX), I think of it as a second home. I often write articles sitting at a bar in Starbucks. Sitting at the bar, I peer out the front-facing window to the front entrance of Chandler Fashion Center, a mall owned by Macerich (NYSE: MAC).

The Chandler Fashion center is elegant, with marble floors and a front entrance that’s absolutely beautiful. It’s a 1.5 million square-feet mall, and its surface to ceiling height is absolutely breathtaking.

I sit inside Starbucks watching the passerby’s as they walk around swishing their GameStop, Apple, Victoria’s Secret, Abercrombie & Fitch, Hollister, Fossil, and Nordstrom bags. With an air of confidence you’ll see customers with their latest shopping hauls walk with a sense of pride and excitement.

I spend a countless amount of time in Starbucks and often find that it's located in some of the most active and beautiful spots in the world. You will almost always find a Starbucks in some of the best locations; remember the number-one rule of retail is location, location, location.

Earnings highlights

Starbucks came out with some fairly solid earnings results. The company was able to increase its store count by 590 locations, versus the 176 store-count increase it was able to report the year earlier.

The reason for the sudden increase in the number of stores came from the Teavana acquisition. The CEO hopes to turn the high-end tea company into a tea-serving company with open bars and baristas. The company’s expansion into high-end tea, along with the organic growth of Starbucks' stores in the Asia Pacific region, seems to be the primary growth catalysts going forward.

Revenue grew from $430.4 million to $544.1 million, which was an 11% improvement from the year earlier. Operating income grew from $430.4 million to $554.1 million, which was a 26% improvement from the year earlier.

Starbucks was able to improve its operating margin from 13.5% to 15.3%; the 180 basis-point improvement was what drove the operating income up by 26%. A small marginal difference in profitability can make a huge difference in operating income. Having a larger amount of operating income will drastically alter the amount of investment into new Starbucks openings.

The company’s primary growth market is the Chinese Asia-Pacific. This region was able to grow revenue by 8% year-over-year, with the Americas (its largest market) doing fairly well with 6% year-over-year growth. Starbucks has experienced some difficulty in foreign markets, such as Europe Middle East and Africa, which reported a 2% decline in sales and a 1% decline in transactions.

The company had a fairly solid quarter in terms of earnings. Earnings per share came in at around $0.51. The previous year, Starbucks was able to generate $0.40 per share in earnings. It  was able to report a solid 28% improvement in earnings, which beat analysts' estimates of around $0.48 per share; the company surpassed estimates by $.03 per share (a beat of 6.3%).

Alternatives to higher-risk retailers

Domestically, firms like Starbucks are able to post solid growth, with the recent acquisition in Teavana clearly illustrating that specialty firms are able to operate economically and with a higher rate of profitability at mall locations. Specialty stores will continue to populate floor space at malls, so perhaps being the landlord of these tenants could be a lucrative opportunity. This phenomenon helps to give risk investors an opportunity to stay exposed in just about every hyped-up fad that runs through the stock market.

Macerich is a great investment opportunity for those who can’t stomach the volatility of trendy stores like Teavana, H&M, Victoria’s Secret, and Aeropostale. Macerich primarily focuses on high-end retail space (open and closed malls with square footage ranging from 500,000 to 2,000,000). The company was able to report an occupancy rate of 93% for its properties with sales per square footage at around $535 on average.

Over the past 15 years, the company has been able to average year-over-year earnings growth of around 61%. Its high yield is driven by leverage (borrowing money from banks to build property). Macerich has easy access to credit, which comes from its established credibility as a property developer, along with the transparency of the company’s financial condition by being a publicly-traded and audited entity.

That being the case, the company’s current P/E multiple is 34.7, which is attractive when compared to its average 15-year growth rate. The company also offers a hefty dividend yield of approximately 3.4%, which should keep income-oriented investors happy when compared to the awful yields from U.S. Treasuries. The stock has been able to out-perform the S&P 500 over the past five-years.

The changing competitive landscape

Starbucks has been in heavy competition with McDonald’s (NYSE: MCD), which has re-focused its whole brand concept from being fast and cheap. The major fast-food chains have adopted more of a health-conscious approach to food, and have also raised the prices on food products in order to maximize profitability.

McDonald’s has been refocusing its efforts on improving the overall customer experience by re-modeling pre-existing stores and driving unit sales by improving the overall satisfaction and quality of the dining experience.

Like Starbucks, McDonald’s must aggressively keep up with the changing trends, which involves improving the overall layout and experience of stores. McDonald’s posted more or less a flat quarter, with 1% growth in both revenue and net income. The company’s performance was flatter than a football field, which may imply that investors are better served by investing into higher-growth names like Starbucks.

Starbucks' revenue growth of 11% for the quarter outperforms McDonald’s 1% year-over-year growth. McDonald’s trades at an 18.7 earnings multiple compared to the 32 multiple-over-earnings for Starbucks.

Starbucks trades at twice the price-to-earnings multiple compared to McDonald’s but comparatively grew revenue 12x faster than McDonald’s for the quarter. Overall, Starbucks seems to offer better value for the amount of growth.

Guidance and conclusion

Starbucks posted a fairly solid quarter. The company’s sudden acquisition of Teavana was what led to the sudden increase in revenue year-over-year. Analysts' earnings projections were beat because Starbucks was able to manage the Teavana operation in a way that would generate greater profitability than what was anticipated.

Going forward growth will be sustained as the CEO is leading the company to aggressively expand into other products and brands, while at the same time rapidly increasing store count in China.

The Teavana brand is likely to expand directly into China, as the country is one of the world’s largest markets for tea. Combine high-end tea with the fastest-growing country, and you have a winning business segment. Clearly Starbucks is on the right path, and there’s no question that investors should stay on top.

Comparatively it out-does McDonald’s in terms of growth and valuation. There’s no question that investors will be able to fetch a reasonable return on investment. The restaurant industry is fairly stable and predictable. What will lead to Starbucks’ growth are its proven business model, excellent management, and continuous store growth.

Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends McDonald's and Starbucks. The Motley Fool owns shares of McDonald's and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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