6 Reasons Starbucks Will Continue Being a Stock Star

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Starbucks (NASDAQ: SBUX) closed 8% higher on July 26 after beating earnings estimates when it announced its fiscal third-quarter results the day before. Given its size and valuation, some wonder whether the rock star among coffee retailers still has room to run. I'm going to cover six reasons why its star should continue to shine.

First, a brief recap of its quarterly results:

  • Revenue increased 13% to $3.7 billion
  • EPS increased 28% to $0.55
  • Comparable store sales grew 8% -- U.S. and China/Asia Pacific were particularly strong at 9%

Reason 1: CEO 

Top management is a huge factor in a company's long-term success. Winners often keep winning – and Howard Schultz has proven he can win. Schultz has a strong business model to work with and should adeptly guide the company to the winner's circle in newer markets (notably, Asia), just as he's done in the U.S.

Reason 2: Coffee is addictive & nearly recession-proof 

Starbucks is in the right business. It sells a product that many not only love, but crave. Sales of coffee are less sensitive to challenging economic times than are other consumer discretionary products. 

The major coffee players are having a great year. Starbucks' stock is up 39%, cafe chain franchiser Dunkin' Brands (NASDAQ: DNKN) is up 44%, and single-serve coffee king and Keurig maker Green Mountain Coffee Roasters (NASDAQ: GMCR) is up 327%. 

Reason 3: Atmosphere

Starbucks' cafes are aesthetically-pleasing, comfortable, and clean. And there's free Wi-Fi, to boot. 

I find the knocks at Starbucks' coffee as "over-priced" interesting. Just as with all restaurants, one pays not only for the meal, but also for the atmosphere and service. The three comprise the "experience."

For those who want a huge selection of tasty coffees, an ever-expanding selection of food and beverage offerings, and a pleasing environment in which to enjoy their goodies, Starbucks has few to no peers among the chains. (Panera Bread provides the closest atmosphere comparison, in my opinion.)

Dunkin' Donuts? I don't view Starbucks and Dunkin' – at least in my area (the Northeast, Dunkin's roots and core) as strong competitors. While there's surely some customer overlap, they're largely serving different customers. And even for those that frequent both, they're largely filling different needs. If I were a donut person and wanted coffee and donuts to take out, I might choose Dunkin'. But, I'm not going to meet a friend for a coffee or lunch at my local Dunkin'. 

Reason 4: Product & service offerings

Two words sum things up: innovation and leverage.  

Starbucks is always tweaking existing product offerings and expanding into new ones. And it's usually ahead of the curve when it comes to trends in food, beverages, and technology. 

Recent examples:

  • Just tapped Google to make Wi-Fi at its U.S. cafes 10 times faster.     
  • It's teaming with Danone to create Greek and other yogurt products. Products will be sold under the Evolution Fresh, Inspired by Dannon label, and be available in cafes and grocery channels.  
  • Announced in June that Seattle's Best Coffee Frozen Coffee Blends, created with Inventure, were available in grocery channels. 
Evolution Fresh is the premium juice, fruit smoothie, and salad producer that Starbucks bought in late 2011. Starbucks started opening Evolution Fresh juice bars in 2012. It also has added juice items to its cafe offerings, and is - as per the Dannon partnership - invading the grocery channel. 

Then there are the 2012 acquisitions: Teavana and La Boulange. Teavana is a premium tea retailer with locations in shopping centers. Look for Starbucks to do with tea what it has done with coffee -- expand the premium market and turn it into an experience. In a wise move, Starbucks will open the first street-front Teavana this fall in New York City. 

La Boulange is a bakery chain, known for its French pastries and breads. Starbucks is rolling out its baked goods to all its U.S. cafes. It began with its San Francisco area locations in April and moved onto Seattle in June. LA, NYC, and Chicago are slated for fall roll-outs.

Reason 5: Printing money in Asia!  

One of standout quarterly numbers was the China/Asian region's operating margin – 36.2%! That's both a solid increase from 33.7% in Q3 F 2013, and superior to the Americas (22.3%) and Europe, Middle East & Africa (3.2%) regions.

Revenue in the region increased 29% over the prior year's quarter. Growth was due to a 9% increase in comparable store sales plus revenue from 523 new store openings over the year.

Starbucks' region with the highest margin is also growing at the fastest rate. This is a winning equation. 

Starbucks plans to open 700 stores in the region in fiscal 2014, half its total planned openings of 1,400. 

Reason 6: The metrics

Keep in mind Green Mountain is a packaged foods producer, while the others are restaurants. Further, Dunkin' operates on a franchise basis, whereas the majority of Starbucks' cafes are company owned. Franchise locations have higher profit margins. 

<table> <thead> <tr><th> <p><strong>Company</strong></p> </th><th> <p><strong>P/E</strong></p> </th><th> <p><strong>Fwd. P/E</strong></p> </th><th> <p><strong>5-Yr PEG</strong></p> </th><th> <p><strong>EPS growth this yr (%)</strong></p> </th><th> <p><strong>EPS growth next yr (%)</strong></p> </th><th> <p><strong>Operating Margin </strong>(%)</p> </th><th> <p><strong>Profit Margin </strong>(%)</p> </th><th> <p><strong>ROE (%)</strong></p> </th><th> <p><strong>D/E</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p>Starbucks<strong> </strong></p> </td> <td> <p>34.5</p> </td> <td> <p>27.1</p> </td> <td> <p>1.7</p> </td> <td> 10.5</td> <td> 20.4</td> <td> <p>14.5</p> </td> <td> <p>11.0</p> </td> <td>29.0</td> <td> <p>0.1</p> </td> </tr> <tr> <td> <p>Dunkin' Brands</p> </td> <td> <p>37.0</p> </td> <td> <p>23.9</p> </td> <td> <p>1.8</p> </td> <td> 166</td> <td>18.5 </td> <td> <p>42.7</p> </td> <td> <p>19.0</p> </td> <td> <p>23.0</p> </td> <td> <p>5.1</p> </td> </tr> <tr> <td> <p>Green Mountain</p> </td> <td> <p>29.2</p> </td> <td> <p>20.9</p> </td> <td> <p>1.1</p> </td> <td> 74</td> <td>14.6 </td> <td> <p>16.1</p> </td> <td> <p>9.7</p> </td> <td> <p>17.8</p> </td> <td> <p>0.15</p> </td> </tr> </tbody> </table>

Yahoo! Finance & finviz; data to July 30; margins and ROE are ttm, D/E is mrq. 

As I wrote in a July 1 article, "coffee is an attractive space." All these companies sport some desirable investment features.

I think Dunkin's potential lies in being a kind of "non-Starbucks," as it expands out West. Dunkin' also announced earnings last week: revenue up 5.9%, and adjusted EPS up 24%. The revenue bright spot was its Baskin-Robbins International unit's revenue increase of 16%, driven by higher sales of ice cream in the Middle East.  

As I also previously wrote, I favor Starbucks over Dunkin' because, "It's much smaller than Starbucks ... yet its projected EPS growth for next year is slightly less than Starbucks'. And, while debt is cheap these days, it's a negative that it's leveraged to the hilt."

I also favor Starbucks over Green Mountain, as previously expressed: 

Granted, it might not be able to outperform to the same degree as Green Mountain over the shorter-term. However, it's a time-tested leader, and a good match for long-term investors who don't want to concern themselves with some of the potential drawbacks of Green Mountain, namely the ever-present threat of its K-Cups' margins being squeezed by increasing competition. Starbucks' ROE says it all: The company is very efficient at using shareholders' money to generate profit. 

Bottom line

Starbucks continues to successfully leverage its product offerings. Additionally, its expansion plans in Asia, where it enjoys its highest operating margin, bode well for its financial results. Starbucks should continue to be a solid long-term core holding for these two primary reasons. 

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BA McKenna has no position in any stocks mentioned. The Motley Fool recommends Green Mountain Coffee Roasters and Starbucks. The Motley Fool owns shares of 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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