In shopping we feel comfortable paying a premium for a good brand because it signifies reliability and quality that will pay off later.
So why don’t investors apply that same logic to the stock market? Too many investors are unwilling to pay up for the best companies because they’re afraid of high price multiples. They’re drawn to the ‘bargain’ second and third-rate competitors. But when it comes to investing, the best-of-breed stocks are invariably worth it for the piece of mind.
So what’s the best of breed stock in coffee? Starbucks Corporation (NASDAQ:SBUX).
But the P/E ratio is too high! Hasn’t the company saturated the market?
Forget these excuses. Here are five reasons Starbucks Corporation (NASDAQ:SBUX) is still the top name.
Does the company have visible, multi-year growth potential? Yes.
New markets: Starbucks has lots of room to grow in emerging markets like Asia and Latin America. In China alone, analysts project the company could double its store count to 1,500 locations by 2015. India, with a population of 1.24 billion people, remains completely untapped. Starbucks has only nine stores in the country.
New Categories: Starbucks Corporation (NASDAQ:SBUX) is expanding outside of the cafe into the in-home coffee market and the ready-serve beverage segment.
Same-store-sales: Starbucks Corporation (NASDAQ:SBUX) is expanding its product offerings to include new drinks, food, tea, and smoothies with the goal of turning its cafes into a meal destination.
Ability to execute
Ambitious growth plans are great, but does the company have the financial strength and managerial talent to pull it off? Definitely.
Starbucks Corporation (NASDAQ:SBUX) has a clean balance sheet with ample cash and only $549 million in long-term debt. Last year the business generated $1.75 billion in cash flow from operations. Plenty to fund the company’s expansion.
The company’s CEO Howard Schultz has one of of the best track records in American business. During the 1990’s, Schultz grew Starbucks Corporation (NASDAQ:SBUX) from a small regional chain into an international titan. Then in 2008, Schultz returned to the company and completed one of the most successful corporate turnarounds in history.
Can the company protect or expand its margins? For sure.
Last fall, Starbucks introduced the $7.00 grande cup of Costa Rica Finca Palmilera coffee. This is proof positive the company can pass on higher prices if inflation picks up.
Starbucks is also benefiting from a commodity cost tailwind. Coffee prices are falling due to a global supply glut that should boost the company’s gross margin.
Beating the competition
How does Starbucks stack up against other stocks in the space?
Pretty well actually.
Take Tim Hortons Inc. (USA) (NYSE:THI) for example. The company sells eight out of every ten cups of coffee sold in Canada but the company’s market share is under threat as larger American rivals enter the market. Already, we’re starting to see the effects in the Tim Hortons Inc. (USA) (NYSE:THI)’s financial results. Since 2008, the company’s gross margin has declined from 28% to 24% and same-store-sales grew a paltry 2.6% last quarter.
Regional coffee chain Dunkin Brands Group Inc (NASDAQ:DNKN) is a tougher rival. The company’s franchise business model is more profitable. Dunkin Brands Group Inc (NASDAQ:DNKN)’s operating margin was 38% in 2012, nearly triple Starbucks. Franchisees are responsible for input costs so Dunkin’ is also less exposed to rising commodity or labor prices.
The only downside with Dunkin’ is the company’s significantly lower growth late. Dunkin Brands Group Inc (NASDAQ:DNKN)’ and Starbucks are projected to post 15% and 20% annual earnings growth, respectively.
Does the company have a track record of rewarding shareholders? Yes.
Last year the company returned nearly $850 million to shareholders in dividends and share buybacks. While income investor may not be impressed by the stock 1.35% yield, management has the ability to increase this rapidly as earnings grow.
Foolish bottom line
Admittedly Starbucks isn’t cheap but top quality names rarely are. The stock trades at 23 times next year’s earnings, which isn’t bad considering the company’s 20% earnings growth rate. This gives the stock a reasonable 1.15 PEG ratio.
But don’t dismiss Starbucks because of its high P/E multiple. Pay up. You almost never regret buying best of breed.
The article 5 Reasons Starbucks Is Best of Breed originally appeared on Fool.com is written by Robert Baillieul.
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