Can Starbucks Survive Expansion?

Starbucks (NASDAQ: SBUX) is planning a massive and ambitious expansion that might threaten the company’s future.

The company already operates around 25,085 coffee shops worldwide, according to Statista. Now its leadership has unveiled plans to add another 12,000 stores by 2021; that would expand the number of Starbucks locations to around 37,000, if successful.

It will also mark a massive acceleration of expansion because Starbucks opened just 2,042 stores in 206 and 1,677 in 2015. To achieve that goal the company will have to open 2,400 stores a year for five years, which might strain its resources.

Among other things that would make Starbucks larger than McDonald’s (NYSE: MCD) which operates around 36,000 burger joints around the globe. This might sound like good news to some investors because McDonald’s investors received a 127.8% return on equity on September 30, 2016.

Owners of Mickey D’s stock also took home a dividend of 94¢ on November 29, 2016. That was up from 89¢ on August 29, 2016, so it is easy to see why investors are excited about Starbucks’ expansion scheme.

McDonald’s shows why Investors Need to Worry about Starbucks Expansion

So yes investors are taking home more money from McDonald’s, but there are some worrisome developments at the world’s most visible eatery. McDonald’s revenues in particular have collapsed in recent years and that collapse shows no sign of slowing.

McDonald’s reported revenues of $27.96 billion in September 2014; that figure fell to $25.64 billion a year later, and $24.93 billion in September 2016. Revenues under the Golden Arches are $3.03 billion lower than they were just three years ago.

All those additional locations have not translated into revenue growth for McDonald’s. Instead they’ve turned into revenue free fall possibly because the brand has been badly diluted by decades of breakneck growth.

Nor is it just revenues, McDonald’s net income is $384 million lower than it was just two years ago. McDonald’s reported $5.057 billion in net income in September 2014 and $4.673 billion in September 2016.

The burger emporium has been able to weather the storm because of its high profit margin (19.85%) and huge amount of float. It reported cash and short-term investments of $2.267 billion, a free cash flow of $897.6 million and $6.623 billion in cash from operations at the end of third quarter 2016.

Can Starbucks Afford Expansion?

The situation at McDonald’s certainly raises questions about the viability of Starbucks’ expansion plans; after all Starbucks had a lower profit margin at the end of third quarter (14.02%).

Starbucks cash and short-term investments were similar to those at McDonald’s ($2.263 billion on September 30, 2016). Like McDonald’s, Starbucks managed to generate a lot of float in the form of $4.575 billion in cash from operations, and a free cash flow of $897.6 million.

Since Starbucks achieved those numbers with assets of $14.33 billion; less than half of McDonald’s $32.49 billion. One can argue that Starbucks does a better job of leveraging its resources than the fast-food giant. A reason for that might be Starbucks’ products (coffee, tea, pastries etc.) are inherently cheaper than burgers, Egg McMuffins and fries; which can require elaborate preparation and a full kitchen.

So which Stock is better, MCD or SBUX?

Starbucks is definitely the better investment, despite the risks the company’s management team is taking. Some of the reasons it is better include:

• Lower price – $56.52 a share on December 28, 2016, vs. $122.96 for MCD. Note: I think McDonald’s is overpriced and probably headed for a fall. Starbucks is possibly underpriced right now.

• Great return on equity – 49.43% on September 30, 2016. Not as impressive as MacDonald’s 127.8% but I can definitely live with it.

 

• Nice dividend yield 1.5% on December 28, not as impressive as MCD’s 2.94% but without the high price.

 

• A dividend of 25¢ last paid on November 15. The great thing about the SBUX dividend is that it is growing. It was 20¢ on August 2, 2016, 16¢ in 2015, 13¢ in 2014, 10.5¢ in 2013 and 8.5¢ in 2012. That means Starbuck’s dividend has nearly tripled in just four years.

 

• McDonald’s 94¢ dividend (paid on November 29) is also good; but you should remember you can buy two Starbucks shares for less than the price of one MCD.

• Growing revenue as we noted above Starbucks’ revenue is growing – while McDonald’s revenue is shrinking.

 

Starbucks is a really good stock because the company will make money, whether or not its expansion plan works out. Better yet if its’ management can grow the footprint as large as McDonald’s; they might be able to generate revenues and incomes larger than those of McDonald’s because expenses will be lower.