The following article will discuss the investment merits of Starbucks (NASDAQ:SBUX) and McDonald's (NYSE:MCD) from the perspective of a long term growth and dividend income investor. The article will contain my four criteria for choosing the above companies along with a discussion on the likelihood their performance can continue well into the future.
The first criterion that was used was the concept of a "wide moat." A wide moat is a term Warren Buffett made popular to describe the types of companies he searches for. A wide moat is a business that has high barriers to entry that limit the number of competitors that can enter in. Lack of competitors usually indicates some type of pricing power, although this may not always be the case (think auto industry). SBUX and MCD easily meet these criteria. To start a similar business from scratch would be virtually impossible, due to years these companies have spent building out their network of stores and well recognized brand name. The difficulty in replicating their business model offers both companies some type of cushion against competition.
The industry isn't bereft of competitors, as one could argue the industry is highly fragmented, with competitors including Wendy's, Dunkin' Brands, Peet's Coffee, and Burger King Worldwide. From my perspective, the inability as of yet for a competitor to eat into gross margins and arrest the upward trajectory of sales for these two companies, though, indicates a "wide and defensible moat." Moats aren't necessarily permanent as both companies will have to continue to execute to maintain their lofty status.
The second criterion that was used was the ability to dominate the industry. SBUX is a unique company without a real similar competitor. Its uniqueness along with the cache of its brand allows it to dominate the coffee/coffeehouse market along with a very successful line of prepackaged coffee and tea products. It has smaller competitors; however none to date have the scale or market muscle that SBUX possesses. MCD is the largest quick service restaurant in the country. Interestingly, one could make the comment that SBUX largest competitor now could be MCD with its McCafe concept which has been a boon to sales. The ability to dominate an industry augurs well for future profit and dividend growth which is key for our long term strategy.
The third criterion that was used was balance sheet strength. I prefer to invest in under-leveraged companies who are able to generate profit growth through sales rather than financial engineering. Having some balance sheet flexibility allows a company to weather the inevitable downturn in business with relative ease. As we can see from the table below SBUX and MCD pass this test with ease.
Shares Outstanding in millions
Long Term debt in millions
|MCD YEAR||Earnings||Dividends||Shares outstanding in millions||Long Term Debt in Millions||Debt/Equity|
Information provided by Morningstar.
The final criterion used was dividend growth. As we can see from the table above SBUX has a short track record as far as paying dividends to shareholders. I didn't hold SBUX's short history of payments against it; instead I preferred to view it as an ongoing work in progress. The payout ratio is comfortably below 40% which should give them ample room to raise it going forward. MCD has been consistently raising the dividend since 1976 and recently raised it 10% to its current rate of 77 cents a share.
The key for investors today is can past performance be replicated going forward. In SBUX's case I believe the answer is yes. SBUX has begun to aggressively push into the Asian markets which I believe will kick start a new round of growth for the company. Their core products of coffee and teas will be well received in Asia without wholesale changes to the menu. SBUX's offerings will be perceived as a "brand" that will be a lure to customers compared to domestic offerings. I believe the brand factor will allow SBUX to charge higher prices similar to what is found in the US.
SBUX's core offerings will be affordable for a large percentage of the populace. SBUX's products will be priced commensurate to what local wages are ensuring consistent repeat business. Being able to attract consistent repeat business is key for the brands continued growth. I don't believe this will be a problem in the Asian market.
As for MCD, the main driver for growth is also overseas expansion primarily in Asia. While SBUX's core products translates well MCD will have to tailor its menu to local tastes. Management has shown the ability to do exactly that over the last decade with its international expansion.
Chart courtesy of Bigcharts.com. MCD and SBUX have performed similarly since late 2007 with SBUX being more volatile.
I expect MCD to continue to grow its business just not at the same pace as SBUX. I don't view this as a negative as I see MCD as a more conservative play. The more important question is which of the two is a buy at current levels. For that I would have to say is MCD. At its current price a pullback to the 85-90 range would place MCD in my buying zone. For SBUX to trade at a share price that I would buy into it would have to pull back to the 42-45 range which is quite a bit away.
In summary, SBUX and MCD meet the criterion of solid long term dominate restaurant chains. Both have solid growth potential ahead as they expand aggressively into the Asian market. At current levels I find MCD a more attractive play. Thank you for reading, and I look forward to your comments.
Disclosure: I am long MCD, SBUX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am long both companies and plan on holding them for an indefinite period of time. The article is for informational purposes and not actual investment advise.