What Does Rhis Coffee Giant's Future Hold for Long Term Investors?

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Starbucks (NASDAQ: SBUX) has been an inspiring story, to say the least. From a small store in Seattle in 1971, Starbucks can now be found on virtually every corner in the U.S. Before Starbucks, coffee used to be just another drink, but the company has successfully made people want to have coffee over and over again, and only at Starbucks.

Today Starbucks is operating everywhere in America, trading near an all time high and boasting a P/E of 33, which has led many investors think that maybe Starbucks has run its course. Does this argument hold weight, or is Starbucks ready to come back for round two?

Starbucks shows no signs of fatigue

After so many years of dominance in the coffee space, Starbucks shows no signs of deceleration in growth or in profitability. The company’s revenue has grown by more than 10% for each of the last six quarters, and 11.30% for the last quarter, while net income has increased a whopping 287.21% to $1.514 billion in 2012 from $391 million in 2009. The operating margin has more than doubled to 14.01% in 2012 from 4.5% in 2009. These are signs of a strong company whose growth is far from over, implying that investment in the company might still generate healthy returns.

Historically low coffee price provide a medium term tailwind

With the Arabica coffee prices near a 3-year low, management believes its operating profit will at least get a $100 million boost this year and a similar amount next fiscal year. Investors surely won’t mind the extra profits, would you?

Starbucks is on its way to become an international powerhouse!

U.S. undoubtedly is Starbucks’ leading market, generating 75% of the company’s revenue, which is why the company is planning to open more than 1500 new stores in the U.S. by 2015. So with just 25% of its revenue coming from international markets, there is a huge opportunity for Starbucks to achieve record levels of revenue if it could entice customers outside of the U.S.

The giant’s first target is China

With over 830 stores in China today and plans to cross the 1500 figure by 2015, Starbucks has answered all the critics who bluntly stated that coffee will never become a trend in China. Through intelligent mixing of tea flavors into coffee and providing a modern and comfortable environment (which Chinese restaurants lacked) for friends and colleagues to meet up, Starbucks has become so successful in China that management now believes it will be the company’s largest market after the U.S. by 2014.

One of Starbucks’ closest peers, McDonald’s (NYSE: MCD), was the first to target the Chinese market. McDonald’s competes with Starbucks through its McCafe stores, which offer coffee at a cheaper price than Starbucks and have thus posed a threat to the company. McDonald's plans to increase the number of McCafe stores in China by 45% to 750 stores by the end of this year. Apart from that, the company has plans to hire over 75,000 new employees and open 300 new stores this year to accelerate its expansion plans in the one of the world’s fastest growing economies.

Don’t worry India, there’s a plan for you too

India's middle class is expanding very rapidly, and so is their love for coffee. With more discretionary income in their hands and their growing love for a modern lifestyle, the coffee shop industry might be a multi-billion dollar industry in India over the coming 10 years. With just 11 stores in the country so far, Starbucks plans to open around 50 more by the end of this year to participate in India’s growing love for coffee.

Starbucks’ flagship store in Vietnam exceeds expectations

Starbucks launched its first store in Vietnam earlier this year, and according to Mr. Schultz sales are exceeding expectations. Vietnam is one of south-east Asia’s fastest growing economies, and if Mr. Schultz is right then Starbucks might have another winner in Vietnam.

Apart from the above-mentioned countries, Starbucks plans to open 100 more stores in Indonesia and the Philippines in the next 3 to 4 years.

Starbucks doesn’t sells just coffee

Starbucks acquired the specialty tea retailer Teavana last year to participate in the $40 billion global tea market. This will give Starbucks a whole new line of customers from Teavana’s existing 300 stores and another 400 stores which it plans to open this year.

To upgrade its food offerings, Starbucks acquired San Francisco’s beloved local bakery shop La Boulange Café and Bakery. With McDonald’s offering coffee with its fast food menu, it makes sense for Starbucks to offer more food products to retain its customers, and also bring in new customers. La Boulange is a successful brand, and with Starbucks' network this partnership can work wonders for both the companies.

It acquired small, upscale juice-maker Evolution Fresh to tap the $3.4 billion cold-crafted juice market in the U.S., and if this clicks Starbucks might find another billion dollar business segment.

Dunkin’ Brands offers stiff competition to Starbucks

Dunkin’ Brands (NASDAQ: DNKN) competes with Starbucks with its line of stores that sell coffee (more cheapely than Starbucks) and donuts, along with other baked goods. The company has had a superb run since its IPO a couple of years back, and is up over 23% this year.

<table> <thead> <tr><th> <p><strong> </strong></p> </th><th> <p><strong>Starbucks</strong></p> </th><th> <p><strong>Dunkin' Brands</strong></p> </th></tr> </thead> <tbody> <tr> <td> <p><strong> </strong></p> </td> <td> <p><strong> </strong></p> </td> <td> <p><strong> </strong></p> </td> </tr> <tr> <td> <p><strong>P/E</strong></p> </td> <td> <p><strong>33.14</strong></p> </td> <td> <p><strong>44.95</strong></p> </td> </tr> <tr> <td> <p><strong>PEG 5 yrs</strong></p> </td> <td> <p><strong>1.62</strong></p> </td> <td> <p><strong>1.80</strong></p> </td> </tr> <tr> <td> <p><strong>Debt/Equity</strong></p> </td> <td> <p><strong>10.32</strong></p> </td> <td> <p><strong>532</strong></p> </td> </tr> <tr> <td> <p><strong>EV/EBITDA</strong></p> </td> <td> <p><strong>18.52</strong></p> </td> <td> <p><strong>19.61</strong></p> </td> </tr> </tbody> </table>

Over 66% of Dunkin’ Brands stores are located in America, of which 98% are located in North-Eastern and Eastern America, leaving plenty of room for the company to grow both in America and overseas. Maybe that’s the reason why Dunkin’ Brands has higher valuations.

Starbucks’ total number of stores worldwide has seen a 6.3% increase since 2008, whereas Dunkin’ Brands has increased its store count by 4%. In 2013 Dunkin’ Brands plans to open 700-800 new stores, while Starbucks plans to open over 1300 stores. Starbucks opened 337 Teavana stores last quarter to hit a total of 590 new stores, showing that the company still has room for expansion in America through its tea offerings. From these numbers it looks like Starbucks is the one with the faster growth and cheaper valuations, making the perfect recipe for investment!

Apart from the growth factor, the high debt/equity ratio for Dunkin’ Brands is also a cause of worry as it weighs down heavily on the company's earnings.

Where does the whole argument lead us to?

Starbucks' track record speaks for itself. The company has always been at the forefront of innovation and growth, and it still seems to be going strong with new acquisitions and steady expansion.

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harsha lohia 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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