Stay Away From Starbucks, 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 am generally bearish on the food / beverage / cafe market, there are a few producers that are making meaningful inroads in high-growth emerging markets. Others, however, have already had a significant degree of growth factored into their stock prices. I recommend broadly diversifying and eyeing the ones that are trading at an irrational discount to peers…
Why 18.4% Annual Growth Doesn't Justify Starbucks' (NASDAQ: SBUX) Valuation
You have heard the expression "you're late to the punch bowl." How about "the coffee cup has already been drunk?” Well, that's the line that fits for an investment in Starbucks at this point. After more than decades worth of saturating seemingly every street corner in America and abroad, Starbucks has peaked in its growth curve. Yet the Street is going wild over this supposed earnings momentum off of K-cups and other grocery items. What's going on exactly?
First, let's make this point clear: it would take a significant amount of growth to justify Starbucks current valuation. Assuming that the company can grow EPS by 18.5% annually over the next 5 years, the stock would be worth $71.20 at a generous 20x by 2016. In present terms, that figure translates to $44.21. In short, Starbucks is overvalued even after applying generous figures. I believe that the bulls will get hit. Once the market shifts towards companies that will actually appreciate from growth (suffice to say, Starbucks has already factored its in), the bulls are bound to get hit.
Fundamentally, I believe Starbucks is a great company; but, of course, not nearly as great as the market makes up. K-Cups have seen terrific momentum, and it is particularly noteworthy that the coffee producer has been able to mark them up at around 34% premium to the going rate. Tazo Tea has continued to deliver high double-digit returns despite a modest price decline. However, the CPG segment is still quite small, and, though it has EBIT margins (30%) 1,100 bps higher than the domestic average, the packaged coffee market is very intense. Through selling in grocery stores, Starbucks has perhaps inadvertently commoditized its brand and, in a sense, cannibalized future cafe sales.
If you agree and find Starbucks too overvalued, there may be an attractive investment alternative in the food / beverage for you, Mondelez International. The company recently split off from Kraft and holds the more popular core business. Its brand portfolio includes Wheat Thins, Tang, Cadbury, Ritz, Nutter Butter, and Cote D'Or, among many other top names. The other business, Kraft Foods, which it is split off from, targets the North American market with grocery items.
There are several reasons why the international business could outperform. For one, its multiples are at a discount to Kraft Foods despite the emerging market focus. I am also optimistic about the corporate strategy suggested by management's recent decision to buyout an Italian snack business. If it continues to grow through bolt on acquisitions of local producers, it could end its image as a corporate giant resting on its laurels with limited product innovation. The CEO recently came on CNBC and, indeed, mentioned pursuing "tack-on" acquisitions to transition the company from one market to the next.
In contrast to Mondelez, Kraft is only forecasted for low single-digit growth. It is more of a safe play, since the corporate strategy henceforward seems to be to resting on the laurels. That's fine for defensive investors, since the company can simply grow each year off of growing consumer expenditures. However, it is not fine for investors that are seeking outperformance through the full recovery. For that, Mondelez is the better pick given its greater risk and aggressive growth strategy.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Starbucks and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.