This growing coffee chain is ready to explode

A once-hot company may soon take a backseat to a rising rival. Here's why.

By StreetAuthority Feb 20, 2013 5:15PM

By David Goodboy

I'll never forget my first visit to Starbucks (SBUX). Many of my friends were talking enthusiastically about this fancy new coffee shop from Seattle that had just opened in the neighborhood. When I saw the prices and the strange names of the beverages, I nearly fainted in surprise. Heck, I could buy an entire meal at McDonald's (MCD) for the price of one of Starbucks' drinks.

Not to mention, it had the nerve to name a small cup of coffee, "Tall." Strange words such as "Venti" and "Frappuccino" quickly became part of yuppie culture and then rapidly spread to all demographics, as Starbucks grew into the behemoth brand it is today.

Soon, paying up to $5 for a cup of coffee became acceptable. This fact alone proves the amazing marketing machine of Starbucks.

There is no doubt this company has become the undisputed king of coffee shops. But cracks are starting to show in its armor.

The bar has simply been set too high for this thriving brand. Despite the company's soaring profits, global expansion, aggressive acquisitions and immense popularity, it failed to meet fiscal first-quarter revenue expectations. During the 2013 fiscal first quarter (ended December 2012), Starbucks earned a little more than $432 million, with revenue of $3.8 billion, just short of the $3.85 billion analysts were expecting.

I realize that's not much of a miss, but it illustrates the point that the company must continually and aggressively reach higher to keep up with expectations.

Stocks are anticipatory mechanisms, meaning prices move on anticipation of the future. When things actually occur, the price often moves in the opposite direction than expected. This phenomenon is also known as the "buy the rumor, sell the news" effect. This is why I believe this stock has already expanded beyond its highest expectations, and the top is in or very near.

The technical picture supports this view. Shares have fallen off their highs of $57 and have broken the 50-day simple moving average on the downside. Based on the technical picture, combined with potentially impossible high expectations, I think shares of Starbucks will have a difficult time pushing much higher.

This means current and future investors may want to look elsewhere for profits in the coffee shop niche.

This is where Dunkin' Brands Group (DNKN) comes in.

Investors who want exposure to the coffee-house craze have a better chance of making profits with this stock. Here's why...

1. Relatively new IPO

Believe it or not, the long-time and successful Dunkin' Brands is a relatively new stock. After going public with a $420 million-plus initial public offering (IPO) in July 2011, the company is still riding on the freshness of the shares.

2. Franchise structure lessens debt worries

The No. 1 item Dunkin' sellers mention is the high debt level of the company. It's no laughing matter that interest on the company's debt is expected to be more than $60 million this year. But this fact is mitigated by the franchise expansion structure of the brand. When the company expands, the costs are carried by the individual owner of the particular Dunkin' Brand store. This means the heavy debt load shouldn't affect expansion plans nearly as much as it would in a company not reliant on franchises to grow.

3. International expansion

While Starbucks is already established in multiple international locations, it's lost its uniqueness in many markets. Dunkin' Brands could reignite the coffee experience as it expands globally. The company recently announced a franchise agreement with Vietnam Food and Beverage Co. Ltd., to assist in building the brand in Vietnam.

The company has more than 10,000 locations in 32 countries today. In 2012, aggressive international expansion started with moves into India and Guatemala, as well as growth in existing markets such as Germany, Chile, Colombia and the United States with an expansion into Southern California. The United States accounts for 75% of the company's revenue and more than 80% of its profits. As international expansion catches on, I can only see revenue and profits climbing higher.

4. Climbing dividends and strong performance

If you're a savvy investor, then you probably understand the importance of increasing dividends. Simply put, one of the best ways to maximize your returns is to invest in businesses that have a record of raising dividends.

Dunkin' Brand just raised its quarterly dividend by 4 cents to 19 cents a share, representing a 27% increase compared with fourth-quarter 2012. Revenue climbed 6.1% and adjusted operating income added 15.3% on a 52-week basis in 2012. Earnings per share soared 38% to $1.28 year-over-year.

5. New products

Dunkin' launched more than 30 new products during 2012 and tested 40 unique new items in various markets. This continual innovation will likely result in new, high-profit items becoming standard fare within the chain.

6. Strong technical picture

Dunkin's stock price has been climbing higher since mid-November 2012. It is well above the 50- and 200-day simple moving averages, and supported with a solid upward sloping trend line.

Risks to Consider: Anything can and does happen in the stock market. No one knows the future and no matter how strong a company looks, things can quickly change. Always position size properly and use stops when investing.

Action to Take: Dunkin' Brands is a good buy right now in the $37-38 range with a $45 18-month target.

David Goodboy does not personally hold positions in any securities mentioned in this article.

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6Comments

Best

Feb 21, 2013 12:57AM

The future coffee king, will be the travel mug from home. The gas prices will cause people to make different choices.

Previous replies

Sensible31648

Feb 20, 2013 9:16PM

How much and how many different brands and flavors do you need for coffee? If you are paying more than fifty cents/cup for coffee...that's too much. Glad I don't drink it...water is just fine.

Previous replies

LeBear

Feb 20, 2013 10:40PM

Yo! Sensible31648:

Hey, me too.

But this is about an investment idea, and a very good one.

I don't care who's POTUS, I got to take care of my families future.

So, in a tough economy, people tend to trade down and/or shop less.

If they don't (can't) make a delicious pot of coffee for pennies like I do, a lot of them will trade down.

I'm putting DNKN on my watch list as soon as I finish this post, and I'll be doin' my homework as I watch this market/economy come to grips.

Thanks to the author, Mr. Goodboy, for a well written, informative article.

That's why I come in here in the first place.

T

Previous replies

whyarewehere

Feb 21, 2013 3:05AM

I'm not too excited. If it hits, it won't match Starbuck's. Dunkin got in to late. Starbuck's is the big fish, with the big market share. Dunkin will only be doing what so many other companies have done with coffee....and that is copy cat Starbuck's.

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Re-TOG Re-TOG (Re-TOG)

Feb 21, 2013 4:02PM

I would have thought Starboogieman, might have copied Dunkin' 10,000 stores is nothing to sneeze or cough at...And I rember where there use to be more Dunkin' Donut Shops...

Some of the older locations probably closed a few years ago..??

Some of their properties were in valuable locations.

And Coffee shops or Houses have been around since early 50s or before, where the Bohemians or Hippies hung out...And people(actors/comedians/musicians) tried out their Wares and new material.

Previous replies

Re-TOG Re-TOG (Re-TOG)

Feb 21, 2013 10:04AM

Dunkin Donuts and coffe has been around for over 40 years...Always had good coffee with a slightly different flavor then homemade brew..

More robust with a deeper flavor...

They may not have been noticed that much until their IPO in 2011 ??

But they have been around forever as "privately owned franchises."

Unless they re-organized a few years back...?

And possibly they were a Regional type company...?

Some of us would make them our coffee stop and get fresh rolls or donuts back in the early '70s.

Previous replies

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This growing coffee chain is ready to explode

A once-hot company may soon take a backseat to a rising rival. Here's why.

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