Dunkin Brands Group Inc (NASDAQ:DNKN) and Starbucks Corporation (NASDAQ:SBUX) are two of the largest players in the extremely competitive quick-service restaurant group, but they couldn’t be more distinct.
Starbucks Corporation (NASDAQ:SBUX) has devoted itself to the high-end coffee market since its inception in 1985, though it has boldly been pushing into other product lines lately. These areas include tea, juice, prepackaged meals, and at-home coffee. It has perfectly blanketed the entire US with a huge network of cafes, as well as expanded its business in other regions like Europe and Asia. It went public on Wall Street in 1992, and has a mix of both company-owned and licensed stores.
By contrast, people like to go to Dunkin’ Donuts for cheap coffee and not because they’re seeking a total coffee experience. It is primarily known for that scrumptious breakfast combination of doughnuts and coffee. The company, however, is attempting to boost its midday-to-afternoon traffic by offering a broader meal selection. While it’s gradually expanding to the rest of the US, it still has by far the most presence in the Northeast. Dunkin Brands Group Inc (NASDAQ:DNKN) went public in mid-2011, owns Baskin-Robbins, and is almost 100% franchised.
Help from the coffee itself
One indicator of profitability for companies that deal with coffee, especially Starbucks Corporation (NASDAQ:SBUX), is the recent favorable movement in coffee futures. They are trading at their lowest value in three years and are approximately 30% lower compared to the same period a year ago. Recent numbers suggest that there is a mounting concern about excessive global coffee supplies exceeding demand by a wide margin. This excessive supply is due to an incredible crop this year in Brazil, which is the top exporter of coffee in the world.
Inventories will continue to pressure coffee futures in the future as well. On top of that, Brazil has plans to increase its coffee shipments next season by more than 6% because farmers have over supplies from last year’s record crop. Inventories actually are up 75% from 2012 and are sitting at the highest level in more than three years.
All told, this is excellent news for both Starbucks Corporation (NASDAQ:SBUX) and Dunkin’ Donuts as they use Arabica coffee, a variety grown in Latin America and Brazil. The weather helped farmers in Brazil, resulting in a record crop. And as coffee futures continue to fall, gross margins at both Starbucks and Dunkin’ Donuts should show improvements in the coming quarters.
High valuation
Both Starbucks Corporation (NASDAQ:SBUX) and Dunkin’ Brandsl have pretty high P/E ratios. Starbucks has a P/E ratio of 32 whereas Dunkin’ Brands has a P/E ratio of 42. These are well above the industry average of 22, indicating that they are expensive when compared to their peers, but the general market feeling is that their future growth will justify these high current multiples. Starbucks and Dunkin’ Brands are expected to show compound earnings growth for the next five years of 19% and 16%, respectively.
Still, the P/E ratio doesn’t tell us about the amount of debt that a company has, and as you check the balance sheet of Dunkin’ Brands, it will be obvious that it has quite a lot of it. But most of that is the reminiscence of its days under private equity ownership. Dunkin’ Brands has as debt-to-equity ratio of more than 400%, not something you would have liked to see. Starbucks is the clear winner in this category with a debt-to-equity ratio of only 10%.
Impressive sales numbers
While Starbucks was hit hard by the recession, it’s coming back more energetically and has reported some excellent same-store sales numbers; 7% for last fiscal year company wide, 8% in the Americas region, and a whopping 15% in Asia. On April 25, Starbucks released its latest quarterly earnings report revealing 7% same-store sales growth in the US, so the pace of sales growth is continuing at an impressive rate.
However, the Asia-Pacific region including China experienced quarterly comparable-store sales growth of 8%, which is a sequential decline of almost 3% from 11% in the previous quarter. And it is almost half of the 15% growth for the same period a year ago. Nevertheless, China still remains Starbucks’ most promising region for international expansion with far more room for growth down the line. Even with the deceleration in the Asian region, Starbucks still managed to report overall stronger comparable-store sales growth in the quarter, both domestically and abroad.
The other player
No discussion of coffee or Starbucks is complete without mentioning of Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR). The company recently saw an incredible 26% jump in the share price (from $60 to $76) when it reported solid second-quarter results, and also announced a long-term strategic partnership with Starbucks.
Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR) generated second-quarter sales of $1.0 billion, up 14% from the year before, and mostly inline with the consensus estimates of $1.0 billion. A stronger year-over-year operating margin resulted in a solid 42% increase in operating income, coming in at $212 million. Net Income from continuing operations rose by a similar percentage to $133 million, or $0.87 per diluted share. EPS came in at $0.93 per share, handsomely beating consensus estimates of $0.73 per share.
The most important takeaway from the release was that Green Mountain feels that it currently has only 13% household penetration with its Keurig system, which leaves significant growth opportunities for its future. Green Mountain has created a strategy of using new technologies, brands and geographies to drive this growth. In the end, Green Mountain seems comfortable with its long-term revenue growth outlook of between 15% and 20%.
Conclusion and recommendation
All and all, a tough call here. My two cents: if you think Starbucks’ international success will continue, then based on both valuation and balance sheet, it would be a better buy than Dunkin’ Brands. On the other hand, if you believe in Dunkin’s 16% earnings growth and remain comfortable with its level of debt, then you can sway toward the tasty combination of doughnuts and coffee.
But if you ask me to choose it for you, I would go with Starbucks. It has an impeccable balance sheet, attractive valuation, a long track record of delivering growth, and its premium brand is well positioned for a successful future in an improving economy.
Sarah Richard has no position in any stocks mentioned. The Motley Fool recommends Green Mountain Coffee Roasters and Starbucks. The Motley Fool owns shares of Starbucks
The article Strong Fundamentals Make Starbucks a Better Investment originally appeared on Fool.com and is written by Sarah Richard.
Sarah is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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