McDonald's vs. Starbucks: Not Much of a Coffee Fight

Starbucks' same-store sales growth is running at 4%, below its historical norm but above that of most retailers. If anything, the fact that most of McDonald's rollout will be complete next year could ease the pressure on comp. sales.

If further convincing is necessary, just look at the expected sales numbers. McDonald's wants specialty drinks in 14,000 stores to add $1 billion to sales. In 2006, Starbucks had an average store count of approximately 6,500 and produced $6.5 billion in sales from them. In other words, they are still selling 14 times as much coffee per store as McDonald's.

The further incursion from the remaining one-third of McDonald's expansion, even under the generous assumption that 100% of those sales would have otherwise gone to Starbucks, amounts to about 4% of Starbucks' trailing 12-month company-owned retail sales -- about one year's worth of same-store sales growth at worst.

The Starbucks Way

Meanwhile, over the last 12 months, Starbucks has generated $1.2 billion in cash flow from operating activities and used just $1 billion to expand those operations by 15%. Assuming that two-thirds of the capital expenditures went to open new stores and the rest was routine maintenance, the free cash flow from its existing store base is approximately $700 million per year, for a 3.5% free-cash-flow yield on the $20 billion enterprise value.

It isn't what I would call cheap, but it is much less like a wounded animal than a healthy tiger pouring its energy into a continued pounce by opening still more stores. At its current expansion rate, in two years, the free-cash-flow yield would exceed that offered by Treasuries, and Starbucks would still be only halfway through its expansion plans.

The Bottom Line

I would consider the stock cheap if it went down another 15% to $22.50, or if it just stayed at about the current price for another year. Since neither of those outcomes is certain, Starbucks fans will have to pick their own entry point.

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At the time of publication, Trent was long Starbucks, although positions may change at any time.

William A. Trent, CFA, is a freelance equity analyst based in the New York metro area. He has been an equity analyst since 1996 and is co-author of Understanding and Evaluating Prospectuses, Offering Documents, and Proxy Statements. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Trent appreciates your feedback; click here to send him an email.