2 Great Coffee Companies For 2 Americas

Includes: DNKN, SBUX, VCR
by: Emmet Kodesh

Coffee, pastry and food companies Dunkin' Brands (NASDAQ:DNKN) and Starbucks (NASDAQ:SBUX) could not be more different in style, demographic base and pricing. Both are excellent outfits with great growth profiles, innovative and expanding product lines and, in the case of SBUX, hi-tech delivery platforms. Most importantly to investors, both are primed to grow with the increasing bifurcation of American society.

DNKN, with less impressive overall metrics than SBUX may outpace its older, giant cap cousin because of the ongoing structural impairment of America's QE-dependent economy. Next year the complex regulations, taxes and costs of Affordable Care (and a potential hit to Social Security benefits in the "chained COLA" proposal) will further hamstring the economy, stressing the middle class. However, SBUX and even more so DNKN will benefit indirectly from this damage, which is in the process of creating two Americas. While the companies appear to be competitors in the same sector, they in fact complement each other, having distinct customer bases. Moreover, part of the appeal of SBUX is its super-green progressive stance on indigenous communities, recycling, health and education issues.

SBUX and DNKN will thrive despite deepening economic distress and markets juiced by debt and skating on thinning ice. Demographics, economic and cultural trends are working for them and they have evolved with them.

From its base in the greater Boston area, DNKN is expanding rapidly through the American south and west and internationally. Derived from Dunkin' Donuts coffee and pastry shops and the Baskin-Robbins ice cream - yogurt chain, DNKN now has 18k sites worldwide and in 2012 had $8.8 billion in sales. In August it opened 19 new sites in Texas and 45 in California. Its market cap is $4.8 billion with 14% growth and a robust 36% ROE, second best in its sector to growth marvel TJX (NYSE:TJX) at 51.9% ROE and growing at 7.6%, another strong buy I often have commended.

A misconception embedded in market nomenclature obscures the essential nature of both DNKN and SBUX. Each in its own way is not discretionary but essential to the formation and expression of identity, social relationships and status. For instance, those familiar with Dunkin' Donuts shops in the Northeast know that for many customers they function like old-time diners: one sees tables lining windows or outside in temperate weather at which people sit and talk for hours. DNKN coffee is good and inexpensive. So are the crullers, muffins and bagels. While most people take out, it also is a sit-down and schmooze place for the lower three quintiles. That is a demographic advantage supporting DNKN's growth. Coffee lovers seek its pink and orange sign and the distinctive fragrance of baked sweets is relished by many people. The company also offers a steadily expanding array of breakfast sandwiches, variations on the bacon, egg, cheese and muffin model that are American staples. One often finds DNKN in a small shopping mall while, in the Northeast, a typical SBUX will be in a bookstore, often in a university building as at BU in Kenmore Square, Boston. It also is involved in "Food for the Hungry," children's health, disaster relief and other charitable initiatives.

SBUX sells the atmosphere of being hip and cutting edge. That is part of its high-end pricing and affiliations with one-cup coffee makers like Keurig and its owner, Green Mountain Coffee (NASDAQ:GMCR). The baked goods are fine and the ambiance is a vital part of the package: young, hi-tech, educated and belonging or looking to belong in the top quintile. The demographic base for SBUX will shrink and solidify but it is durable and has money to spend. It is a company that like Apple (NASDAQ:AAPL) or Mercedes Benz (OTCPK:DDAIF) helps establish and express social coding and class. Moreover, SBUX is cutting edge in its mixture of refined taste, ethics and organic living. It partners with Save the Children, Ethos Water and Farmer Support Centers from Costa Rica and Colombia to Rwanda, Tanzania and China. Like many miners, it embraces community building and successfully sells it as part of its commitment to a world of socially conscious latte sippers.

SBUX also leads in technical innovations. It has mobile apps for ordering from your table, reward points and was among the first public venues to provide free Wi-Fi. It has the advantage of unified and skilled leadership: Founder (1971) Howard S. Schultz still is Chairman, CEO and President. He clearly has fulfilled and continues to refine a vision.

These are long-term reasons to understand the bedrock position of SBUX amid transformative times. Its outstanding metrics make it a strong buy, if not immediately given the debt-ceiling, budget and Health Insurance Mandate, then on the next string of red days. The cash flow alone of SBUX is 4 x debts and revenues are 26 x debts. Its tiny .10 debts/equity are reflected in a 33 coverage ratio. Its ROE is very good, 27.9. Primarily a growth play, it yields 1.1% on a moderate 38% payout.

DNKN's ROE is 33% higher at 36. To finance its expansion, DNKN is carrying significant debt but still has a decent .9 quick ratio. It yields 1.7% on a 55% payout in line with major companies in the sector: Johnson & Johnson (NYSE:JNJ) and McDonald's (NYSE:MCD) at 55% payout, Coca Cola (NYSE:KO) at 57% and Procter & Gamble (NYSE:PG) at 59%.

In moves that enhance its posture as a health and socially conscious, SBUX has banned guns in its stores and engaged a joint venture with organic and health food retailer Whole Food Markets (WFM), also a top company with zero debt and high growth (13.1%) to carry its juices and three brands of trail mix snack bars. It has strengthened its brand identity and offerings with La Boulange and its trademark Tazo Tea.

These are two great companies positioned for sustainable growth aligned to the otherwise discomfiting and widening socio-economic division of America. While SBUX is the market's darling with superb metrics few stocks surpass, the growth of DNKN should be strong and durable. It will be opening 150 outlets in the UK in the next five years, 50 in London alone. It already is established in 60 nations worldwide and its brand is likely to become a favorite with millions of people with limited money to spend and a taste for sweets, bread and good coffee.

DNKN is up 45% YTD and 100% (doubled) since 1Q 2012. SBUX has risen 55% YTD and 276% in three years since 3Q 2010. Since the 4Q 2008-1Q 2009 bottom it has risen tenfold and clearly has upside. Its worldwide presence features 4000 stores in the Asia-Pacific region and nearly 21,000 in all. In the decade from 2002-2012 its revenues quadrupled from $3.3 billion to $13.3 billion on a market cap now approaching $58.5 billion.

In my view, every investor should have an overweight position in these companies. Those who prefer to distribute their risk and diversify into the sector can use the Vanguard Consumer Discretionary ETF (NYSEARCA:VCR) in which SBUX and DNKN are the eighth and 110th holdings. The relatively small weighting of the latter might be additional reason to own DNKN as an individual equity if you choose to play the sector, +30.7% YTD, via this low cost ETF.

Disclosure: I am long DNKN, SBUX, WFM. 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.