2 Coffee Stocks With Upside Potential
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Starbucks (NASDAQ: SBUX) and Dunkin’ Brands (NASDAQ: DNKN) are the two leading coffee chains in the country. To accommodate the current trend for high quality coffee and the popularity of coffee shops in general, quick-service restaurant giant McDonald's (NYSE: MCD) also introduced McCafe, a café-style accompaniment to McDonald's restaurants in the style of Starbucks. McDonald’s McCafe provides an affordable alternative and can attract customers who view Starbucks as expensive. Though McDonald’s has benefited from its line of McCafe drinks, and the higher-margin coffee and blended drinks now constitute more than 10% of the company’s revenues, we favor Dunkin’ Brands and Starbucks over McDonald’s as we believe these companies provide better growth prospects.
Dunkin’ Brands stock has recently tumbled below $29 for the first time in 5 months. While the bear case is built over the company’s lofty valuation with respect to other quick-service & fast casual restaurants, and the company’s high debt to equity ratio, we believe there is a reason that the company enjoys high levels of Insider (31.23%) and Institutional Ownership (66.80%). We believe, premium valuation metrics for the stock are justified by the company’s solid growth profile and asset-light business model (nearly 100% franchised), which can yield substantial increases in free cash flow over a long-term horizon and provide defensive characteristics that should allow the company to perform well in a wide variety of economic scenarios.
The company has been expanding internationally and paying down its debt as well. DNKN recently completed the 15 million share repurchase from its sponsor group for $30, and the private equity firms completed the secondary offering for 21 million shares of stock. The 36 million combined shares (21 million offered via secondary and 15 million repurchased by Dunkin’s Brands) reflected the private equity group's remaining holdings of Dunkin’ Brands. We think the additional liquidity in the stock should be viewed positively.
We continue to remain optimistic about the company growth prospects (See: Dunkin Brands: High on Donuts) as we believe the company is well positioned to generate mid to high single digit top-line growth and average 20% EPS growth annually over the coming years, driven by its Dunkin’ Donuts U.S. concept, which accounts for roughly 70% of total system-wide sales. While relatively small presently, we see a nice opportunity for Dunkin International to continue broadening out its footprint and ultimately becoming a bigger contributor to the company’s overall results.
On the other hand, Starbucks recently announced a $25 million deal with Square (mobile payment company) to use the futuristic payment system in 7,000 of its chains nationwide, which could mean the end of the old way of paying. This fall, Square will begin processing all credit and debit card transactions at Starbucks stores in the United States and eventually customers will be able to order a Grande vanilla latte and charge it to their credit cards simply by saying their names. With Square’s full GPS technology, the customer’s phone will automatically notify the store that the customer has entered, and the customer’s name and photo will pop up on the cashier’s screen. The customer will give the merchant his or her name, Starbucks will match the photo and the payment will be complete.
The company started as a coffee joint and expanded its range of goods with pastries, baked goods and beverages. The recent deal is a good example how the company has been intelligently using its strong balance sheet. Following disappointing 3Q results, the stocks took a beating. However, the stocks have recovered well as expected (See: Starbucks Earnings: Does the recent drop present an entry point?). We remain bullish on the stock as the company has multiple growth drivers including K-Cups, Verismo system, VIA, Refreshers, Evolution Juice, La Boulange and packaged coffee. Moreover, there is a promising growth outlook with company’s strong acceptance in China as evident from a double-digit Q3 SSS growth in China.
Thus, we prefer Starbucks and Dunkin Brands over McDonald’s. Starbucks stocks are recovering well after a downfall and we expect a healthy recovery in Dunkin Brands’ stock as well.
TheAnalystBlog has no positions in the stocks mentioned above. The Motley Fool owns shares of McDonald's and Starbucks. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.