Will the Champion Retain the Coffee Cup?

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At the moment, the retail value of U.S. coffee market is a staggering $30-32 billion. With 20,366 stores in 61 countries, the American coffee giant, Starbucks (NASDAQ: SBUX), is the largest coffeehouse company in the world. The company has been enjoying a significant market share in the U.S. for the last few years but recently, it has faced some tough competition from the likes of McDonald’s (NYSE: MCD)Dunkin’ Brands (NASDAQ: DNKN), Wendy’s and Burger King. Given the fact that the restaurant industry isn’t on a rise, what should we expect from Starbucks in 2013?

One dollar reusable cups

Starbucks is about to offer its customers $1 reusable plastic cups. According to the company, the customers would be served in the same cups (cups would be cleaned with boiling water) each time they bring them back. These cups were tested in 600 stores in the U.S. and would be introduced soon in the whole North American region. This comes as a part of company’s goal of serving 5% of all drinks in reusable cups by 2015.

Currently, Starbucks is earning a gross margin of 11% on its sales, but with more competitors making inroads in the coffee market, the margins are bound to get smaller in the future. Therefore, decreasing costs in the long run is of foremost importance to the company.

Most expensed restaurants in the U.S.

When it comes to consumers’ choice for coffee, Starbucks still remains one of the favorite spots in the U.S., but the competitors are gradually bridging the gap. According to a travel and expense company, Starbucks is one the favorite spots for employees when it comes to business travel. On average, employees expensed around 21,000 transactions at the company, with a bill of $7.54. The hamburger giant, McDonald’s grabs the second spot with 12,420 transactions and an average bill amounting to $6.73. While Subway recorded a total of 8627 transactions, it had an average bill of $11.88.

(Source: www.nydailynews.com)

New tax policy in the U.K.

During the past few months, the lawmakers in the U.K. have severely criticized Starbucks for avoiding taxes in the country. As a result, the company has finally announced that it would pay taxes in excess of 10 million pounds in each of the next two years. 

Starbucks has more than 700 stores in the U.K. and has been operating in the region for the last 14 years, yet it has paid only 8.6 million pounds in taxes. According to the company, it hasn’t done anything illegal, as a foreign company doing business in Europe is allowed to base itself anywhere in the 27 EU nations. The company has been paying royalties in Netherlands, where it has established its headquarters.

The matter of fact is that these new tax regulations in the U.K. will have a major effect on Starbucks’ cash flows. Starbucks is earning a healthy 29% on its equity, plus a payout ratio of 47% depicts that the company is keen on returning money back to its shareholders. With far less cash on hand in 2013, it won’t be easy for the company to grow its dividends like it did before (In 2012, company’s dividends grew by 24%).

(Source: http://www.telegraph.co.uk)

Valuation

Starbucks is currently trading at a forward P/E (1yr) of 20.92x and is yielding a dividend of 1.50% on its stock. Though the industry’s P/E is 30.62x at the moment, Starbucks should sell at a 5% discount to industry’s P/E amid higher taxes in the U.K.

According to the consensus estimates, Starbucks should be selling at $62.80; hence, it has an upside potential of 14.6%. Moreover, the mean target price from the sell side is $60.32, which means it’s undervalued by 10%.

Competitors

McDonald’s

Starbucks’ biggest competitor, McDonald’s, have started selling bags of ground coffee at its restaurants in Canada. At the moment, its ground coffee is available at Canada’s 1400 stores. According to the company, if the coffee does well, it could spread throughout the world. McDonald’s has a habit of trying its new products in a specific region, before making it a worldwide product. Same was the case with McCafe coffees, which were first launched in Australia before being introduced in the U.S and Europe.

For the last couple of years, McDonald’s coffee has played a pivotal role in driving its revenues. As John Betts, President of McDonald’s Canada says “If you want to be a credible player in the restaurant industry, you have to have a great cup of coffee.” You can have a look at my detailed take on McDonald’s here.

More and more retail food  understand the fact that coffees are an essential part of their business, which have a large room to grow in the future. As a result, Starbucks is not only facing tough competition from McDonald’s, but also from the likes of Burger King and Wendy’s. The recent addition of coffee frappes in Burger King’s menu has shown a lot of promise. Moreover, Wendy’s have also started to test its specialty coffee in select markets.

Dunkin’ Brands Group

Starbucks’ second biggest competitor in the U.S. is Dunkin’ Brands. At the moment, the company has more than 7,200 restaurants in the country. Moreover, the company has plans of opening 15,000 restaurants in the U.S. in the next 20 years. The company has a long term goal of having more than 1000 restaurants in California.  As part of this plan, the company has initially decided to open a series of restaurants in Southern California. According to the company, it would also be opening chains in airports, casinos, military bases, universities and super markets. Last year, the company opened 291 restaurants in the U.S and in 2013, the company plans on opening a further 350 restaurants.

With a catchy tagline, “America runs on Dunkin,” the company has been putting more emphasis on its coffee in the last few months. Moreover, the company is marketing itself as a far less expensive brand than Starbucks. Dunkin’s CEO, Nigel Travis said that the company would also increase its drive-thrus in California, as it can have a major effect on company’s revenues. The company has already expanded itself in western states like Nevada, Arizona and Colorado.

Conclusion

Starbucks, McDonald’s, Dunkin’ Brands, Burger King and Wendy’s would share the coffee market share in 2013. With more tough competitors in the market, it wouldn’t be easy for Starbucks to earn abnormal profits during this year. High healthcare costs would mean less spending in the restaurant industry. More affordable brands like McDonald’s and Dunkin could benefit to a great extent from this. Moreover, with the new tax regulations in the U.K, Starbucks wouldn’t be able to increase its dividends this year. If they do so, then they would have to sacrifice their long term growth. Given the fact that McDonald’s and Dunkin are investing more in the coffee business, Starbuck can’t afford to slow down its own growth. Having said this, the new strategy of introducing $1 cups would certainly pay off in the long run. In short, Starbucks doesn’t seem that attractive in the short run.

 

 

 

 

 

 

 

 

 

 

 

 

 


Vamosrafa7 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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