Forget Starbucks: This Coffee Stock Is Better

By
A A A

"One dollar for a cup of coffee -- they are out of their minds!" my frugal, land-speculating grandfather said when we stopped at the local corner gas station on the way to visit one of his properties.

Having lived through the Great Depression, he was convinced that coffee shouldn't cost more than a quarter a cup. A book could be filled with his assorted old-timer economic beliefs -- such as the $5 union-rate haircut -- but I'll never forget his reaction to the $1 cup of coffee.

I wish he would have lived to see the rise of Starbucks (Nasdaq: SBUX ) and its $6 cups of coffee. He would have certainly had a few choice words for people like myself who patronize the wildly popular high-end coffee emporium.

Not only did Starbucks change the way coffee is viewed, but the company has made its investors wealthy. Shares have tripled in value to around $75 over the past three years. This success has spawned a variety of copycat operations. Some of these are established companies that have added gourmet coffee products to their existing lines; others are regional startups.

One Starbucks-influenced company that morphed into a gourmet coffee profit-making machine is none other than the once humble Dunkin' Brands (Nasdaq: DNKN ) .

Flickr/Paul Downey
Although the Dunkin' Donuts brand has been around since 1950, Dunkin' Brands is relatively young as a public company.

I was pleasantly surprised that a Dunkin' Donuts I recently visited in South Carolina offered free Wi-Fi, a lounge area full of leather chairs, a variety of coffee flavors, sandwiches and, of course, donuts that are vastly superior to Starbucks' offerings. During my travels recently, I have noticed Dunkin' Donuts sprouting up in the same general areas as established Starbucks locations. This strategy resembles Burger King's (NYSE: BKW ) pursuit of McDonald's (NYSE: MCD ) locations.

I think my grandfather would still believe the prices at Dunkin' Donuts are too high, but Dunkin's prices are lower than Starbucks. This lower price point, combined with the wide variety of quality products and coffees, provides a strong incentive for many consumers to favor Dunkin' Donuts over Starbucks. This is particularly true when the stores are as comfortable as the newly opened location I recently visited.

I like how Dunkin' Donuts is operated, its business ideas, and the quality of the products -- not to mention the fact that its stock is up nearly 30% this year.

Dunkin' Brands is close to being a 100% franchised business. This means the owners of the 10,400 Dunkin' Donuts restaurants in more than 60 nations (and almost 7,000 Baskin-Robbins ice cream parlors, which Dunkin' Brands also franchises) provide the capital for the brand's expansion.

Flickr/renaissancechambara

Dunkin' Donuts has morphed into a gourmet coffee profit-making machine.

This transferring of the expansion costs to the individual franchise owner is a brilliant and powerful means of growth. When compared to Starbucks company-owned and -financed store concept, the expansion potential is clearly on Dunkin' Brands' side. While Starbucks' market cap of more than $53 billion dwarfs Dunkin' Brands' less than $5 billion, the innovative nature of Dunkin' Brands should close this gap over time.

Although the Dunkin' Donuts brand has been around since 1950, Dunkin' Brands is relatively young as a public company. In 2006, a group of private equity firms purchased the company, and an initial public offering followed in 2011.

In the second quarter, earnings per share ( EPS ) rocketed 24% higher from the same period a year earlier, and revenue rose by nearly 6%. Perhaps more importantly, domestic same-store sales increased 4% for Dunkin' Donuts and 2.6% for Baskin-Robbins during the same time.

This is a powerful tell on the future direction of the company. It shows that consumers are willing to purchase more products at a higher price point, which will drive the bottom line higher.

The company also recently initiated a dividend. Although nothing spectacular, the dividend is currently yielding 1.8% and was increased from last year, which may be the start of regular annual increases. Another positive move is Dunkin' Brands' repurchase of 400,000 shares of common stock; management has another $33 million available for additional buybacks.

Risks to Consider: The gourmet coffee craze may not last forever. Consumers are fickle, and tastes change. There is also fierce competition in the space with even the fast-food giant McDonald's vying for a piece of the action. Always use stops and position size properly when investing.

Action to Take --> Price has pulled back to the 50-day simple moving average setting up a strong value buy zone opportunity. Buying now in the $43 range with stops at $42 and a 12-month target of $48 makes solid investment sense.





The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.


This article appears in: Investing , Investing Ideas , Stocks

Referenced Stocks: EPS

StreetAuthority

StreetAuthority

More from StreetAuthority:

Related Videos

How to Save Money at Bars
How to Save Money at Bars           

Stocks

Referenced

Most Active by Volume

44,823,339
  • $75.19 ▲ 0.28%
43,744,171
  • $3.44 ▼ 0.29%
42,340,022
  • $97.671 ▲ 0.66%
34,178,145
  • $17.62 ▼ 1.23%
34,028,998
  • $15.59 ▼ 0.19%
32,055,708
  • $21.23 ▼ 2.41%
31,539,235
  • $3.76 ▲ 0.80%
30,434,619
    $34.25 unch
As of 7/25/2014, 04:03 PM