Stocks: Go With The Essentials

by: Glenn Rogers

I write this while I'm flying from Los Angeles to New York on Jet Blue (NASDAQ:JBLU). To be more specific, my flight left from Long Beach airport which for readers who have not had the "pleasure" of passing through it is little more than a collection of trailers with some blacktop and a soft drink machine. It's a great place to fly out of if you live in Laguna Beach, as I do, since it is only half as far as LAX and the line-ups are 100% shorter. This nearly inspired me to recommend airlines as a buy in general and Jet Blue in particular, as Barron's did this past weekend. But I have never done well with airline stocks so I have decided to recommend two products that are more down to earth: coffee and hamburgers.

The markets have been crazy of late so we need to stay defensive, as I pointed out in last month's column in which I recommended ETFs based on utilities and consumer staples. This month I want to reiterate that advice and recommend two iconic brands: McDonald's Corp. (NYSE:MCD) and Starbucks (NASDAQ:SBUX).

Both these companies offer the broad global footprints that come with geographic diversification. So in the event that Europe does melt down they have coverage elsewhere and more importantly they have opportunities for accelerating growth in China and India. Let's take a quick look at them individually. I say quick look since I'm pretty sure everyone reading this has either been a customer of one or both, perhaps many times over the years. Yes, I know that Canadians are loyal to Tim Hortons (THI). But that stock is already on the IWB Recommended List and Tim's, good as it is, does not have any overseas growth profile.

McDonald's Corp.

McDonald's is the largest fast food franchise in the world with over 33,000 stores and 400,000 employees. Incredibly, 80% of the properties are still owned and operated by individuals. The company has revenues of over $24 billion (all figures in U.S. currency), over $5 billion in profits, and they are still growing. August marked their 100th consecutive month of positive global comparative sales growth and the stock pays a dividend of nearly 3%.

Second-quarter results provide a good overview of the company's growth. Global comparable sales increased 5.6% during the three months to June 30. The U.S. was up 4.5% (healthy but below average), Europe gained 5.9%, while Asia/Pacific, Middle East and Africa gained 5.2%.

McDonald's shares recently sold off a little when the company released some results that were slightly below where the Street thought they should be. This was despite the fact the company reported second-quarter earnings per share of $1.35 (fully diluted), up 19% from the same period in 2010, or 11% once foreign exchange gains were factored out.

I think the pull-back gives investors a chance to get in at a reasonable price and enjoy a decent yield with consistent growth and a product mix that is perfect for lean economic times. At 15.4 times forward earnings, the shares don't look expensive and given the uncertainties that surround us peace of mind is worth a great deal.

The company took a lot of heat a few years ago around the time that the Super Size Me movie came out and their menu was rightly attacked for being fatty and generally unhealthy. But they have made serious attempts to improve in that direction. (Anyway in China they don't seem care.) The other area that McDonald's has apparently improved is the quality of their coffee. I say apparently because I don't drink it but I am told that it is excellent and much less expensive that the Starbucks version. Plus you can get fries with that!

Action now: Buy with a target of $98. The shares closed on Friday at $88.29.


The headline story on Starbucks is that since the founder, Howard Schultz, has returned to run the company the business has dramatically improved. The other headline is that Mr. Schultz recently announced aggressive expansion plans in both China and India, with more than 1,000 new stores in China alone. Also underway are major expansions in South Korea where they plan to open several hundred locations.

Starbucks has also revived their Seattle's Best brand and partnered with Burger King and Subway which will give them access to 30,000 additional locations and help beat back the McCoffee attack. I have also been impressed by the company's reaction to rising coffee prices. Some of their competitors tried to cut prices at just the wrong time, whereas Starbucks maintained their prices and worked on frequent buyer reward programs.

Revenues are coming in at $11 billion this year with EBITDA of over $2 billion. At 21.5 times forward earnings, Starbucks may not seem cheap but the growth that lies in front of them more than justifies the current price and sure looks reasonable compared Green Mountain Coffee Roasters (NASDAQ:GMCR) at 42 times.

In July, the company reported results for its fiscal 2011 third quarter (to July 3). Net revenues increased 12% year-over-year to $2.9 billion. Global comparable store sales increased 8%, driven by a 6% increase in traffic and a 2% increase in average ticket. Consolidated operating margin was 13.7%, up 1.2 percentage points over prior-year period's GAAP results. U.S. operating margin improved three percentage points to 18.8% on a GAAP basis. International operating margin improved two percentage points to 12.2%.

Earnings per share rose to $0.36, up 33% from $0.27 a year ago.

"Starbucks record third quarter results reflect both the underlying strength and continuing momentum we have been experiencing across all of our business segments and around the world," said Mr. Schultz. "These results demonstrate the power, and the extraordinary global potential, of our unique new business model. Starbucks has never been healthier, more connected to our customers and partners, or better positioned to go after the tremendous business opportunities that lie ahead."

Like they say, people have to eat (and drink). Even in tough times most people will cut back on a lot before they give up their caffeine and parents will still need an inexpensive place to take their kids for a snack after the soccer game or the ping pong game, depending on where they are in the world. Both these iconic American brands have become truly international and will continue to thrive over the long haul while offering defensive positions during times of market turbulence.

Starbucks pays a quarterly dividend of $0.13 a share ($0.52 annually) to yield 1.3%.

Action now: Buy with a target of $46. The stock closed on Friday at $39.20.

Disclosure: I am long SBUX.