After a prolonged period of massive expansion, Starbucks dominates its industry. In the process, the company has enriched its shareholders with huge returns. The stock has more than doubled in just the past five years. But whether Starbucks is a good investment is a different question.
Investors looking to buy Starbucks likely do so because of its growth, which is impressive. That said, investors who want to own a piece of the coffee giant have to pay a steep price for the privilege. As a result, there may be better dividend stocks than Starbucks, in terms of risk vs. future reward.
Neither Starbucks nor DineEquity is a member of the Dividend Achievers, a group of 265 stocks with 10+ years of consecutive dividend increases. You can see the full Dividend Achievers List here.
Despite this, both should appeal to dividend investors (for different reasons). Here's a look at why DineEquity may be a better dividend stock to buy than Starbucks right now.
Business OverviewWinner: Starbucks
There is no doubting Starbucks' success. It was once thought laughable that a company could have success charging $5 or more for a cup of coffee.
Starbucks proved them wrong.
For example, in fiscal 2016, Starbucks grew total sales by 11%, to $21.3 billion. This was due in part to new store openings, as well as 5% growth in global comparable-store sales, a measure that indicates performance at stores open at least one year.
Starbucks' earnings-per-share increased 4.4% for the year, to $1.90. Excluding certain non-recurring costs, adjusted earnings-per-share rose 17%. It has generated strong growth over an extended period.
Specifically, Starbucks has grown its earnings-per-share at 19% a year from 2013 through 2016.
By comparison, DineEquity is struggling. It owns the IHOP and Applebee's brands, which posted comparable-sales declines of 0.1% and 5%, respectively, in 2016. Making matters worse, DineEquity has encountered worrying management turnover. Within a few weeks, DineEquity announced the resignations of its CEO and CFO.
Applebee's is the big area of concern for the company. Consumers are moving away from sit-down restaurants, in favor of faster, more convenient options.
In response, the company is deploying a number of measures to fix this.
It is rolling out new initiatives designed to keep up with consumer preferences,. The company is switching Applebee's from pre-packaged microwave food to freshly prepared foods in an effort to improve its dining experience.
It will also expand its to-go capabilities, and improve its food quality, with the hopes of differentiating it from its closest competitors. These are promising initiatives, and could work well to boost traffic. Still, despite these measures, investors will need to be patient. DineEquity expects Applebee's comparable sales to decline another 4% to 8% in 2017.
Growth Prospects Winner: Starbucks
Starbucks has two key growth catalysts: new-store openings and price increases. First, Starbucks is aggressively expanding its store count. The company opened 2,042 net new stores last year, and plans to open 2,100 net new stores in 2017.
Compare this with DineEquity, which has a much more modest restaurant expansion schedule. It plans 20 to 30 net closings for Applebee's this year, and 75 to 90 net openings of IHOP restaurants, most of which will be in the international markets.
But, the company has a 5-point plan to return to growth (found in the 2016 Baird Conference Presentation, page 5):
Change the story at Applebee's
Sustain IHOP's momentum
Accelerate franchise restaurant development
Build a more nimble company under one roof
Thoughtfully explore strategic acquisitions
Starbucks' growth potential is definitely higher than DineEquity. However, there are considerable risks associated with Starbucks' bold expansion plan, and it is the same risk that got Starbucks into trouble many years ago. That is, the risk of over-expansion.
Eventually, new-store openings may take traffic away from existing Starbucks locations. By opening more than 2,000 stores each year, Starbucks could start to cannibalize itself.
Starbucks has laid out some ambitious growth projections going forward (found in the December 2016 Biennial Investor Day, page 10):
- Mid-single-digit comparable-store sales growth
- 10%+ revenue growth
- General & administrative expense growth of 50% of revenue growth
- 15% to 20% long-term earnings-per-share growth
- Achieve greater than 25% return on invested capital
- Have revenue greater than $35 billion in fiscal 2021
- Double operating income through fiscal 2021
Starbucks expects more than $35 billion in annual revenue by fiscal 2021, which would represent 64% revenue growth from fiscal 2016.
The risk for investors is that the company over-promises and under-delivers. This is particularly worrisome if the U.S. economy slows down.
Luxury discretionary items are often the first thing cash-strapped consumers cut back on, when the economy sputters.
If the U.S. economy enters recession in the not-too-distant future, consumers may decide to scale down. That daily trip to Starbucks could easily be swapped for a daily trip to McDonald's(MCD) - Get Report.
While DineEquity clearly is not a growth company, it doesn't have to be, because the stock is dirt-cheap, with a huge dividend yield.
Valuation & Dividends Winner: DineEquity
There is little doubt Starbucks' growth prospects are stronger than DineEquity's.
The problem with buying Starbucks stock is that its growth may already be priced in. Based on 2016 EPS, Starbucks trades for a price-to-earnings ratio of 30. Starbucks has an above-average multiple -- the S&P 500 holds an average price-to-earnings ratio of 26.
Starbucks has a fairly high valuation, particularly if growth does not meet expectations. Starbucks comparable-store sales growth has declined from 8% a year in 2011 down to 6% a year in 2016.
And, the decline has accelerated in recent quarters. For example, in the fourth quarter, U.S. comparable-store sales increased 4%. Growth then slowed again in the first quarter, to 3%. If these trends continue, Starbucks' lofty valuation multiple could contract.
Meanwhile, DineEquity stock trades for a price-to-earnings ratio of just 10, based on 2016 adjusted earnings per share. At such a cheap valuation, there is much more room for error. Not a lot has to go right for DineEquity, in order for shareholders to earn significant returns. However, Starbucks is nearly priced for perfection.
The other big disadvantage of buying Starbucks stock at such a high level is its very low 1.5% dividend yield. Consider that DineEquity has a 7.2% dividend yield -- more than four times as high as Starbucks.
When comparing two stocks in similar industries, buying the one with a much higher dividend yield and lower valuation can often be the right decision. Importantly, DineEquity's dividend appears secure.
DineEquity generated $112.5 million of free cash flow in 2016. Its dividend costs the company $67.4 million. That means, even with its declining sales, the company covered its dividend payout by 1.7 times.
In fact, there was enough cash flow left over to repurchase $55.3 million of its own shares. Continued buybacks will help support EPS.
So again, DineEquity's problems are known and priced in. By contrast, the expectations for Starbucks are very high. Buying stocks with sky-high multiples can result in poor returns, if the underlying growth does not meet expectations.
So, with cracks appearing in the core U.S. market, there is a considerable risk of buying Starbucks now at a price-to-earnings ratio of 30. With a single-digit price-to-earnings ratio and a 7.2% dividend yield, DineEquity stock demonstrates the appeal of buying when there's "blood in the streets."
At the time of publication, Reynolds was long MCD.