Why I'm Buying Starbucks

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

America runs on caffeine, and Starbucks (NASDAQ: SBUX)) has done a great job of tapping into that need for over a decade. Even though the stock is at all-time highs, now is a great time to get in.

Accretive investments

The MyStarbucks Rewards program showed 30% growth year-over-year in the past quarter. The Starbucks Card also continues to impress, with 38% more dollars loaded on Starbucks' cards compared to the third quarter of FY 2012. Over 10% of transactions in Starbucks’ U.S. stores involve a smartphone. Investing in these technology-based rewards programs will continue to strengthen the Starbucks brand over the long term by increasing the costs of switching to other coffee-makers.

The single-cup coffee category is a big area of potential growth; Starbucks recently sold its billionth k-cup, and revenue grew by 51% compare to the same quarter last year. Management recently announced an extension of the partnership with Green Mountain Coffee Roasters, which will continue the company's long-term expansion in this area. The purchases of Evolution Fresh and, more recently, Teavana will enable Starbucks to branch out further into opportunities outside coffee.

General competition

Any comparisons with other companies will be imperfect, since Starbucks occupies a unique niche at the intersection of tea, coffee, and baked goods - another reason I like the stock. Krispy Kreme Doughnuts (NYSE: KKD), Dunkin' Brands (NASDAQ: DNKN), and McDonald’s (NYSE: MCD) are, to my mind, the closest competitors. For all four, coffee is a significant portion of the business, and all are associated to one extent or another with breakfast foods and baked goods.

Financial comparisons

For same-store sales, Starbucks performed well in this group, with an 8% comp gain for the third quarter in fiscal year 2013 (including 9% in the Americas and a 7% rise in global traffic), compared to McDonald’s with 1% growth, Dunkin' Brands at 4%, and Krispy Kreme with an astounding 11.4%. Other metrics are less kind to Krispy Kreme; the company's operating margin for the trailing-12 months is 9.4%, as compared to Starbucks at 16.0%, Dunkin Donuts at 41.1%, and McDonald's at 31.1%.

Earnings-per-share growth for Starbucks for the third quarter of FY 2013 was a superb 28% year-over-year (from $0.43 to $0.55). Even so, Dunkin' Brands exceeded Starbucks by this metric, with growth over 100% year-over-year (to $0.38 from $0.15), as did Krispy Kreme, with growth of about 38% (to $0.11 from $0.08). Only McDonald's under-performed Starbucks, with EPS growth of 4.5% (to $1.38 from $1.32).

To look at these various metrics, Starbucks would seem to be a good investment, but perhaps not as good as Dunkin' Brands, Krispy Kreme, and McDonald's. But the numbers don't tell the whole story.

The best value

There are three reasons why I view Starbucks as the best value for a long-term growth stock out of all of these companies: 

1) Millenial appeal: These consumers (myself included) will grow in their share of the market as they age and make (and spend) more money. McDonald's is having difficulty connecting with millenials, which makes the chain a riskier proposition than Starbucks (although I still view McDonald's as a good investment due to its juicy dividend and consistent earnings).

Starbucks, by contrast, is acknowledged as a leader among millenials and seems to be cited every time anyone wants to make a point about appealing to young people (see here, here, and here). A big piece of the brand appeal is Starbucks' image as a company pushing for social justice (think Fairtrade coffee, for example).  As millenials increasingly drive "capitalism with a conscience," these initiatives set the brand apart from the competition.

2) Product differentiation and competition: Krispy Kreme and Dunkin' Brands offer primarily donuts and coffee. They are in direct competition with each other, and so there will be some tendency to cannibalize each other's sales. McDonald's has a variety of offerings, but is in direct competition with these companies for its breakfast and coffee lines, and with Burger King and Wendy's for its lunch and dinner products.

Starbucks competes with these other firms in terms of many of its offerings, but the Tazo and Teavana lines are completely different. Moreover, there is a difference in the quality perception - Starbucks' products are viewed as better quality (and worthy of a premium cost), so the chance of these other companies cannibalizing its sales is relatively minor.

3) Valuation and risk: Starbucks trades at a P/E of 34.8 based on earnings from the trailing-12 months. This makes it a relatively expensive stock, but that's the price you pay for a rock-solid balance sheet, a debt/equity ratio of 0.1, and consistent EPS growth ($0.43 for FY 2008 grew to $0.52 in FY 2009, $1.24 in FY 2010, $1.62 in FY 2011, and finally $1.79 in FY 2012).

McDonald's P/E is 17.9, but the lower P/E prices in fears about millenials and the chain's ability to continue growing - it's riskier. Krispy Kreme trades for a P/E of 65.4 and Dunkin' Brands for 47.4 - in both cases, very expensive, even for a growth stock. While I view them both as businesses likely to grow in the long term, the valuations are too rich for me. Starbucks strikes the right balance of low risk and reasonable valuation given the firm's performance.

Foolish conclusion

Starbucks is a great long-term growth stock that has been paying investors very well for many years. It is comparatively expensive right now, but I believe the company's growth story is just beginning, as its comp, revenue, and earnings growth point to a healthy business with great long-term staying power. Add it to your portfolio today.

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Michael Douglass 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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