Is Starbucks a Buy?

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

Starbucks (NASDAQ: SBUX) is looking more and more like it will repeat history and continue its trend to a higher share price.

The year so far has been weak for what the coffee shop is used to, with the share price climbing about 23% so far this year, compared to the S&P 500's 16% growth. 

The increase in price at Starbucks might look impressive, but considering the stock has appreciated by about 260% since 2008, and the S&P 500 is up just 20% in that time, much of the growth the coffee shop was experiencing looks to be waning. However, an improving economy and prospects overseas could keep the momentum intact.

Finding the right time to buy

Starbucks is facing a $2.9 billion lawsuit from Kraft Foods (NASDAQ: KRFT) over a $500-million-a-year distribution deal between the two companies beginning in the 1990s. After incredible success, Starbucks wants out of the contract, and offered to pay $750 million to do so. However, according to the contract, Starbucks has to pay fair market value for the business, in addition to a 35% premium. That is now estimated to be near the $2.9 billion figure. The lawsuit is expected to be settled sometime this year.

Despite the heavy weight on Starbucks' shoulders, the company is worth nearly $50 billion, and the lawsuit wouldn't be a game changer for the company, which has shown interest in expanding to India, China, and Indonesia. That means once the lawsuit is settled, any dip could trigger a buying opportunity following the likely sell off. 

On the flip side

Shares of Kraft could increase if the company is able to secure the $2.9 billion. However, that modest increase in capitalization wouldn't make an impact on the company's ability to perform. Anyone waiting for a pullback in the price of Kraft, which is up about 20% so far this year, will likely instead see an inflated price given any lawsuit settlement in its favor. The growth of the company will likely slow after its recent restructuring efforts and low-cost pricing initiatives. 

Starbucks looks to profit from the economic recovery

During the recession, many people found cheaper ways to drink coffee. McDonald's (NYSE: MCD) started using Arabica beans for premium roast coffees in 2006. That created some competition for Starbucks, but now the economy is improving, and the chances of coffee drinkers returning to Starbucks is likely. That will take away profits from McDonald's.

McDonald's is a fairly unattractive stock right now. The firm missed analyst estimates by $0.01 last time. Earnings and revenue increased during the recession, as the company often caters to those wanting to conserve money. Now that the economy is recovering, it won't just be the coffee sales that McDonald's loses out on, but the entire menu probably.

Morningstar gives McDonald's a fair price of $105, while it is hovering around $100 lately. However, the fast-food industry is increasingly competitive, and I see share price falling. But before ruling the stock out, you should consider the massive advertising budget ($788 million in 2012). That could sell a lot of coffee. In short, you may want to check up on McDonald's every quarter to see if it is actually losing market share to Starbucks. If not, it may be worth a buy.

Starbucks looks strong

With consumers nearly fully recovered from the recession, Starbucks and its high-end coffee brand look to become reacquainted with lost customers. Having that in mind, I would wait until the court settlement that could lead to Starbucks having to pay Kraft the $2.9 billion. If that happens, a sell off would likely ensue, providing investors with a chance to get in on this rapidly expanding company.

The best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.

Phillip Woolgar 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!

blog comments powered by Disqus