2 Coffee Stocks Presenting Investors With Great Opportunities, Despite Recent Earnings

by: Matt Schilling

On Thursday, July 26th, Starbucks (NASDAQ:SBUX) reported dismal results for the June quarter, and the stock sold-off roughly 10% during after-hours trading. Analysts were expecting Starbucks to earn $0.45/share, however the company actually reported results that were $0.02/share lower at $0.43/share, and lowered its outlook for the second half of the year. I can completely relate to the fact that $4 for a cup of coffee is a bit expensive, but I don't think pricing is the issue. That said, there are several reasons why I like Starbucks and direct competitor Dunkin' Brands (NASDAQ:DNKN) at currents levels.

Examining Both Coffee and Cocoa

Before I get into an analysis of the companies mentioned, I wanted to first look at the commodities behind some of America's favorite coffee brands. First, cocoa (CCU12.NYB) is up almost 110 points over the last five sessions, which equates to a gain of nearly 4.9%. Second, coffee (KCU12.NYB) is down nearly 11 points over the last five days, which equates to a loss of nearly 5.9%.

The performance over the last week should equate into higher profit margins in terms of coffee, and lower profit margins in terms of cocoa. Why'd I focus on cocoa as well? Most premium coffee providers, such as Starbucks and Dunkin', offer cocoa-based drinks, whether they be frozen frappuccinos, hot chocolate, or a variation of the two, and therefore the commodity should be considered when discussing these brands.

The Positive Catalysts For Each Company

Even though Starbucks reported dismal earnings, CEO Howard Schultz touched on two very important catalysts with regard to Starbucks. The first is growth, and considering it was yet another quarter of record growth, even though there were things beyond the control of the company, I'd say the quarter was pretty good. Mr. Schultz noted that:

Despite coming in short of our expectations I am pleased with the increasing operating leverage we are seeing, the fact that this was our 11th consecutive quarter of record results and the fact that we achieved the results in the face of high legacy commodity costs and challenging economic and consumer headwinds in key markets.

The second catalyst in terms of Starbucks is clearly global expansion. Expansion can be broken down into two segments, products and presence. What investors may not know, is the fact the company plans on expanding its products to reach the areas of beer and wine, as well as energy related beverages. This, in fact, could ramp up competition for brands like Red Bull and Monster (NASDAQ:MNST). The company also plans to increase its presence both domestically and internationally. Domestically speaking, Starbucks is planning a push for expansion in the Sacramento region of California, which would be the first time it has done so in over two years. Internationally speaking, the company recently opened its 600th location in China, and plans to close a number of European locations as the Eurozone crisis has weighed heavily on the company's growth in the region.

The June quarter wasn't exactly friendly to Dunkin' Brands and as a result, shares have certainly been off their highs. Analysts, such as Zacks, were expecting DNKN to earn $0.33/share on revenue of $170 million for the quarter. The company came virtually in-line with those expectations reporting EPS of $0.33/share on revenue of $172.40 million, which may be considered a beat on paper, but since it wasn't anything spectacular the stock hasn't done much during most of the morning trading session on Friday.

The catalysts for DNKN vary slightly from those of SBUX, however growth with regard to same store sales and expansion both in the US and abroad do play key roles. That said let's focus a bit on the company's expansion. During the quarter there were 140 new franchise locations which included 27 international Dunkin Donuts and 87 international Baskin-Robbins, which highlights DNKN's focus in on strengthening their global footprint.

One of the things I like about DNKN is the fact that the company and their CEO Nigel Travis have noted, that even though there may be a slowdown in consumer spending, the company hasn't nearly felt it as much as other companies may have. Same store sales numbers certainly reinforce that argument, as Dunkin Donuts sales have increased 4% and Baskin-Robbins sales have increased 4.6%. Mr. Travis went on to say that the stores are "having near-record profits, and even though the economy is slowing, single-user tickets have also increased considerably".

A Quick Look at the Competition

There are two companies that stand out as direct competitors for both SBUX and DNKN, and they are Peet's Coffee & Tea (NASDAQ:PEET) and Green Mountain Coffee (NASDAQ:GMCR). First, investors and potential investors should note that Peet's Coffee & Tea has recently agreed to be taken private by Joh. A. Benckiser for $73.50/share or $977.6 million dollars. Analysts at Janney Capital Markets believe:

Peet's would make more sense for a larger packaged food company that would have more marketing muscle, distribution power and cost synergies, as opposed to being part of a private equity portfolio.

In my personal opinion, I think the acquisition of the Peet's brand for under $1 billion is quite a bargain and many of the shareholders have a point, when they note the best interest of the shareholders isn't necessarily that of the board of directors, as noted in several of their recent court filings opposing the transaction.

That said GMCR is also worth a look at current levels, despite the company's clear fall from grace over the last several months. Even though the stock has taken a dive, there has been some talk by my fellow SA author, Rx Stocks, that a buyout or merger is a very good possibility for two reasons. First, the company has a number of patents expiring in 2014, which could make the company a lot more valuable considering the massive global reach of a company like SBUX. Second, the company has reiterated its guidance of 45%-50% in terms of net growth for 2012, which in my opinion, is certainly something to consider if potential investors are looking to establish a position at these levels.

Final Analysis

I think the sell-off in SBUX and non-movement in DNKN have created excellent buying opportunities for potential investors, and the opportunity for existing shareholders to increase their position at a much lower cost. That said, I think the expansion of both Starbuck's and Dunkin' Brands' global footprints will pay dividends in the coming quarters, and if both companies can successfully combat the Eurozone crisis, they'll come out much better than analysts have expected. In terms of their competition, I'd keep a very close eye on Peet's Coffee & Tea with regard to shareholder discontent and Green Mountain with regard to a possible buyout.

Disclosure: I am long SBUX, DNKN.