Don't Drink the Starbucks Kool-Aid, Buy This Stock Instead
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
While I generally believe in the efficient markets hypothesis, there are occasions where stocks can be abnormally beaten down or hyped up. All too often, it's assumed that companies that have achieved awesome growth in the past will so again in the future. Ironically, just the opposite is likely to be the case, since as businesses mature they come under pressure from competition are often overly rejected by the market and become undervalued. Below, I highlight one company that I believe has been irrationally beaten down.
Starbucks is well known for expensive products, but it might as well be known for being an expensive stock. The PE multiple of 27.2x is at a considerable premium to that of its peers and the market overall, so what is the reason for the optimism? Analysts forecast 18.5% annual EPS growth over the next 5 years, which I believe is much too high given that the coffee brand has already saturated seemingly every important street corner. Sure, the company is taking other routes to grow revenues, but the core café business is coming under pressure from competitors, like Dunkin Donuts and likely now McDonald's. While the latter has pushed aside claims of entering this market, it still made a trademark filing with the USPTO to print its agency logo on ground and whole-bean coffee items.
To drive this double-digit EPS return, Starbucks is taking alternative methods, such as selling home-brewers in what is estimated to be an $8 billion global market. This item has admittedly seen strong demand, and it has yet to hit a meaningful number of retail outlets beyond Williams-Sonoma. But macro uncertainty over the last few years may make consumers skeptical about purchasing from premium brands, even in a full recovery.
Therefore, I believe that Dunkin' is a more attractive stock to invest in. The corporate name is a bit misleading, since it leads one to think of just the café chain. In reality, Dunkin' also holds Baskin-Robbins, which is also a solid brand name. But even though I think Dunkin' is more attractive that Starbucks, I still find it overvalued, at around 20x forward earnings and a PEG ratio north of 3.5x.
First, I find it more attractive because the company can easily achieve 10-12% EBIT growth just from unit expansion. Second, I still find it overvalued, because the company will have to use a significant amount of debt to achieve this expansion - around $525 million in 2012. The uncertainty over interest rates rising will prevent multiples from expanding over their currently elevated levels.
Green Mountain Coffee Roasters (NASDAQ: GMCR): The Surprise "Buy"
As is common in value investing, sometimes the most attractive stocks are the most beaten down. After David Einhorn's negative comments over reckless spending and structural weakness drove shares to a local low, Green Mountain has been on the defense. The company appears to be factoring in the worst, given the substantial discount to peer multiples, but only time will tell.
While the company is now exposed to competition from chains like Kroger after the expiration of K-Cup patents (and nearly three-quarters of business comes from single serve packs), it has strong pricing power in the home-brewer markets. It recently decided to cut its price for Keurig Vue V700 down to $230, while launching a discounted $210 brand.
The launch of wellness drinks is also very similar to the strategy that Starbucks has taken (ie. open up new market). However, whereas endeavors like this have been optimistically forecasted into Starbucks' growth trajectory, it has been almost entirely excluded in media commentary on GMCR. At 9x forward earnings, the company is relatively safe from downside and positioned more towards recovering lost shareholder value. As Starbucks fails to achieve the kind of growth needed to justify its valuation, I anticipate GMCR's multiples closer towards the peer average.
Know What You Own
With Green Mountain as cheap as it's ever been, many investors are wondering whether this is the end of the former market darling, or the perfect entry point for an enormous rebound. You can find a recommendation for how to approach investing in the company in The Motley Fool’s new premium research report. In it you'll find everything you need to know about Green Mountain, including whether it's a buy at today's prices. Click here for instant access.
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