The mere fact that Starbucks Corporation (NASDAQ:SBUX) trades at 33 times trailing earnings is an indication of where most investors stand on the issue of whether the company can maintain its growth trajectory and profit margins. The company is the clear leader in the U.S. premium specialty coffee market and has been able to raise prices seemingly at will.
However, while Starbucks will likely continue to lead the specialty coffee market in the U.S. — and expand its market leadership overseas — the company faces increasing competition both at home and abroad.
Unquestionable leader
Starbucks Corporation (NASDAQ:SBUX) is the unquestionable market leader in the U.S. and is in the early stages of an international expansion plan that could lead to more revenue coming from international than domestic locations within the decade. The company’s primary emerging market targets — Brazil, India, and China — are all in the process of building an affluent middle class that will be drawn to premium specialty coffee.
Starbucks’ dominance in the U.S. and mouth-watering growth opportunities overseas make its expansion appear to be unstoppable. However, competition has intensified — both domestically and abroad — over the last couple of years. With no switching costs, Starbucks Corporation (NASDAQ:SBUX) must continually refine its in-store environment and product mix to justify its premium pricing.
Competition on all fronts
In the U.S., Starbucks should be most concerned about Dunkin Brands Group Inc (NASDAQ:DNKN), which has a strong base in the northeastern United States. Although the company has a number of appealing businesses under its banner, including its market-leading Baskin-Robbins concept, Dunkin Brands’ key growth driver is its specialty coffee sales. Specialty coffee not only commands high margins, but also has strong demand for a populace that hooked on coffee.
Dunkin Brands Group Inc (NASDAQ:DNKN) has one important advantage over Starbucks Corporation (NASDAQ:SBUX); while Starbucks builds and manages its own stores, Dunkin Brands sells franchises to independent owners. Investors can make the case that Starbucks captures more of the upside by owning its stores, but Dunkin Brands Group Inc (NASDAQ:DNKN)’ ability to rapidly expand its store presence with little capital investment makes it a major threat to Starbucks Corporation (NASDAQ:SBUX)’ lead in store count.
While Dunkin Brands poses a competitive threat to Starbucks in the U.S., McDonald’s Corporation (NYSE:MCD) represents a threat globally. The company’s fast-food restaurants have the leading market share in every major company except for China. Its McCafe specialty coffee offering has been an enormous success alongside other menu experiments like serving real fruit smoothies and a revamped breakfast menu.
McDonald’s is increasing changing its image to be one of quality, even going so far as to imprint what look like grill marks on its burgers and make its products appear to be handmade, even though they are still produced by machines.
This quality-at-a-discount branding is already infringing on Starbucks Corporation (NASDAQ:SBUX)’ offering, with the latter acknowledging competition from McDonald’s Corporation (NYSE:MCD) coffee offering. However, nobody is going to confuse McDonald’s and Starbucks on the basis of quality; more likely, price-sensitive consumers will increasingly view McDonald’s Corporation (NYSE:MCD) coffee as a viable substitute for Starbucks’, while more affluent customers will not switch.
Like Dunkin Brands Group Inc (NASDAQ:DNKN), McDonald’s has an important advantage over Starbucks Corporation (NASDAQ:SBUX) — it already has a global presence and strong brand equity in every major country on earth. Meanwhile, Starbucks has to build its brand and presence in these markets, which will take time and money that McDonald’s Corporation (NYSE:MCD) does not have to spend.
Bottom line
Starbucks commands a rich multiple for a reason; it is simply the best specialty coffee company on the planet. However, investors must decide if the company can fend off the competition before investing. Will Starbucks Corporation (NASDAQ:SBUX)’ store environment and great-tasting coffee keep customers paying high prices, or will customers eventually go to Dunkin or McDonald’s Corporation (NYSE:MCD) for lower-priced coffee?
It is not an easy question to answer, but any investor who buys the stock at 33 times earnings must be able to answer in the affirmative.
Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends McDonald’s and Starbucks. The Motley Fool owns shares of McDonald’s Corporation (NYSE:MCD) and Starbucks Corporation (NASDAQ:SBUX).
The article Who Can Compete With Starbucks? originally appeared on Fool.com.
Ted 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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