The Investor's Best Brew: A Bean for Every Means

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

Coffee is an exquisite product to consume and to sell.  Millions are mildly addicted to it but can easily afford their daily fix, and unlike many other pleasures of life, moderate caffeine indulgence comes without the buzz-kill of guilt.  According to medical guru Dr. Oz, coffee is actually good for you, offering protection from Alzheimer’s disease, improving short- and long-term memory, and reducing your risk of depression, diabetes and sudden death. 

Restaurants that sell hot coffee also enjoy caffeine-jacked profits from margins many times greater than those typically realized through sandwich and doughnut sales.  Companies like Dunkin' Brands (NASDAQ: DNKN) have made the most of the ‘virtuous cycle’ of our dependence on caffeinated drinks.  Driven to satisfy recurring cravings, many of us will spend a buck or two for the convenience of hot and ready-made.  Then, while we’re in the store or perusing the drive-through menu, we can be tempted with other low-ticket items, such as raspberry muffins or lunch paninis.  But companies that derive the majority of their revenues through hot and cold beverage sales continue to have an edge on other restaurateurs, and investors can perk up their portfolios by purchasing shares in a number of caffeine-dependent enterprises. 

Upscale International

With a presence in 61 countries, Starbucks (NASDAQ: SBUX) undoubtedly owns the world’s most recognized coffee brand.  The company occupies a unique position as a brewer of specialty caffeinated blends and a provider of casual meeting space for business people all over the world.  Fortunately, Starbucks’ concept of an ‘office away from the office’ continues to generate sales of everything from frappuccino drinks to spinach and feta wraps, and innovations like the Verrismo single cup home brewer and mobile ordering apps promise to continue to pad the bottom line. 

Although some market movers have expressed concern over the recent pace of expansion at Starbucks, the coffee maker plans to open 1,300 net new stores in fiscal 2013.  The company has seen double digit comparable store sales over the past few quarters in China, which CEO Howard Schultz expects will become Starbucks’ most significant market outside of the US.  In 2012, Starbucks opened its first location in India where execs believe the company’s concept of ‘affordable luxury’ could succeed as well as it has in China.  Starbucks’ company-operated stores, which account for 80% of total revenue, typically derive 75% of their sales from beverages.

Mid-Cap Blend With a Shot of Growth

Although Dunkin’ Brands sells similar fare and competes directly with Starbucks in many countries, customers can buy most menu items at Dunkin’ Donuts stores for 10% to 30% less than at Starbucks.  Dunkin’ Brands stock debuted on the NYSE in 2011 and currently trades about 35% above the IPO price.  That Dunkin’ shares have sometimes lagged the S&P 500 probably reflects the company’s high debt level and interest payments, as well as periodic new issuances to finance international expansion.  The company has, however, had great success outside of the US, with over 5,400 points of distribution in the Asia-Pacific region and plans to launch another 250 locations this year in Malaysia, Indonesia and China.  Dunkin’ Brands owes much of its steady cash flow to its ‘captive audience’ locations on college campuses and in hospitals and airports.  Dunkin’ Brands’ franchisees get 60% of their revenue from the sale of coffee and other beverages.

Domestic Down Home Cup-a-Joe

Tim Horton’s (NYSE: THI) is the largest fast-food chain in Canada.  It’s also a Canadian icon with a ubiquitous presence in the landscape and a cultural identity that’s difficult to explain to outsiders.  For instance, every Canadian knows what you mean when you want 'a Timmy’s,' and that 'double double' refers to a coffee with two creams and two sugars.  It may also surprise American investors who’ve never heard of Tim’s that the coffee and doughnut franchise has managed to grow its market cap to 7.2 billion (nearly one-tenth that of McDonald’s) almost entirely through Canadian sales. 

For these and other reasons, shares of Tim Horton’s have often traded at a premium to other fast food chains.  Lately, however, Tim Horton’s shares have slumped on slowing same store sales and declining customer traffic in both the Canadian and US segments.  Management blames the weaker numbers on capacity constraints in urban centers, as well as a downturn in consumer spending, and recent reports from Tim’s most comparable competitor would seem to support this claim.  But with over 3,300 stores across the Great White North, some fear that Tim’s may have saturated the Canadian market. 

Others point to store closures in the company’s US operations due to heavy competition from Dunkin' Brands and also from relative newcomers to the palatable coffee space, namely McDonald’s and Subway Restaurants.  Although Tim Horton’s doesn’t provide a breakdown of percent of total sales derived from their hot and cold beverage lines, that eight out of ten cups of coffee sold in Canada are poured in a Tim Horton’s store probably means that the company gets a majority of its revenue from coffee and caffeinated drinks.

<table> <tbody> <tr> <td> <p><strong>Caffeine Fiend</strong></p> </td> <td> <p><strong>1 Year Return</strong></p> </td> <td> <p><strong>Forward P/E</strong></p> </td> <td> <p><strong>Dividend Yield</strong></p> </td> <td> <p><strong>Dividend</strong></p> <p><strong>Payout Ratio</strong></p> </td> </tr> <tr> <td> <p>Starbucks</p> </td> <td> <p>19%</p> </td> <td> <p>21x</p> </td> <td> <p>1.5%</p> </td> <td> <p>38%</p> </td> </tr> <tr> <td> <p>Dunkin Brands</p> </td> <td> <p>35%</p> </td> <td> <p>23x</p> </td> <td> <p>1.8%</p> </td> <td> <p>66%</p> </td> </tr> <tr> <td> <p>Tim Horton’s</p> </td> <td> <p>4%</p> </td> <td> <p>16x</p> </td> <td> <p>1.73%</p> </td> <td> <p>31%</p> </td> </tr> </tbody> </table>


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