Distinguishing between which to buy is especially hard in the coffee business. But there's one potential 'x' factor most analysts aren't citing in their notes, and it's unclear as to whether or not this is priced into the stock.
The consumer is cooling off a bit. If consumer spend continues to shift downward -- especially if spending projections for 2019 and 2020 come in lower than expectations -- some coffee drinkers could switch over to Dunkin' over Starbucks. That would cause Starbucks' ever-important U.S. comparable sales growth rate to come down, and Dunkin's to come up. Starbucks has recently seen a poop in comparable sales growth, while Dunkin's comps are stuck in their doldrums. Plus, Starbucks shares have soared in the past few months. Dunkin' stock has had a different story of late.
Could a downturn be good for Dunkin'?
First, let's look at the facts seen in fourth quarter earnings reports:
The earnings print was positive almost all around, much like its third quarter 2018 earnings report, which was somewhat of a breakout quarter for the stock.
Earnings-per-share came in at 75 cents on an adjusted basis, beating estimates of an adjusted 65 cents a share. GAAP EPS also beat estimates, as the company reported 61 cents a share, beating expectations of 58 cents. That's a 15% growth rate, compared to analysts expectations of a 11.9% growth rate. Revenue was $6.6 billion, handily beating estimates of $4.89 billion. Total revenues grew 9%, beating estimates of 6.8%. Net income was $760 million.
Comparable sales in the U.S. grew at 4 % year-over-year to $4.2 billion. China sales grew 1% to $651 million.
Management guided for revenue growth of between 5% and 7% for the fiscal year of 2019 and global comparable stores growth of between 3% and 4%. Earnings-per-share for the full year of 2019 is expected to be between $2.63 and $2.73 on an adjusted basis. The average analyst expectations for adjusted EPS for the full year of 2019 is $2.65.
Importantly, guidance was very strong. The story for Starbucks in July, when comparable sales growth in the U.S. was growing at around 1%. But that turned around in November when U.S. comparable sales grew at 4%, beating estimates of 2-3%. The coffee giant proved that growth is relatively likely to remain intact for the near future at least with its January 2019 earnings report.
The stock moved up slightly immediately after the earnings, but then popped to $70 a share, where it is now, about 9% above where it was pre-earnings. The stock move wasn't just in response to the earnings, but it also reflects greater optimism going forward, as the forward earnings multiple expanded slightly to 23.2, slightly higher than Dunkin's 22.7.
Earnings-per-share beat estimates, but not because of revenue. Same-stores-sales growth was not exciting, and the outlook for the same metric came in below Wall Street's estimates.
Adjusted EPS came in at 68 cents per share, beating Wall Street's estimates of 61 cents. A favorable tax rate contributed 6 cents per share to earnings, so if one took the positive impact of the tax rate out of the equation, the earnings beat was by one penny. Revenue was $319.60 million, missing estimates of $329.43 million. Comparable sales growth, most of which are in the U.S., was flat year-over-year.
But here's where Dunkin' really diverges from Starbucks. Management guided for comparable sales growth in the low single digits for each of the next two years. Initially, Dunkin' had said it was targeting comparable sales growth of more than 3% by some time in 2020, which now seems like a distant hope, rather than a reality to bet on. One factor potentially driving the disappointing guidance is that Dunkin's roll out of its new next-generation stores, which gets product to customers much faster than old stores do, will happen at a much slower clip than previously anticipated. Management implied the company will roll out 703 net new stores over the next few years, down from the initially expected 1,000.
Dunkin's stock fell from $68.80 a share before the earnings on February 6, to around $67.90, where it is now, so the stock didn't exactly get rocked, and it's trading at almost the multiple Starbucks' is. It seems plausible the stock could fall even more, but it also seems hard for Dunkin's performance expectations to fall even more, suggesting there may be some upside for the coffee and food chain.
Price Targets and Risk Reward
It now seems distinctly possible that Dunkin' might have more upside than does Starbucks. The average price target for sell-side analysts on Dunkin' is $70.44, which suggests roughly 3.7% upside. Starbucks, which looks to have much more growth in it from a performance perspective, has an average price target from sell-side analysts of $69.70, suggesting the stock may slip a bit, as it's currently trading around $70 a share. That doesn't come as a huge surprise, as the last two turning-point quarters have reinvigorated investor confidence in the company, and now a lot of the expected growth is priced in.
So what would Dunkin' have to do to move the stock along, and hopefully create more upside than 3.7%? And what would Starbucks have to do to beat expectations? Perhaps just as critical, how far down would the stock have to move to provide meaningful upside to investors?
Starbucks in the China & U.S.
Starbucks is competing with local coffee and tea brands in China, with Luckin Brands among them. The comparable sales growth in China far lags that of the U.S. for Starbucks, but overall revenues could still spike in the region, as Starbucks plans to add some 3,000 store locations in China over the next few years.
The headwinds to comparable sales in China are very much about competition, as Luckin Brands, a start-up, looks to raise equity capital for expansion. Luckin is also at a lower price point than Starbucks is. Starbucks is seen as a premium luxury brand in the region. Another very real headwind is the risk that the Chinese economy decelerates even more than currently expected, which Starbucks, a consumer discretionary, is sensitive to.
Starbucks investors are looking for the chain to successfully hit its expansion goals, which it may have more ease in doing compared to Luckin, as Starbucks has plenty of cash ($8 billion) and can rely on its steady stream of cash flow. Then, investors have to watch the market share race between Starbucks and Luckin.
in the U.S., Starbucks must maintain its 3% to 4% growth rate. Slipping back to the days of flat to 1% U.S. comps growth could really hurt the stock. Part of that picture is Starbucks' somewhat innovative digital platform that allows for speed and convenience for the customer.
Dunkin's new stores
Dunkin' now has Starbucks' old struggle. It has to get away from 1% comps sales growth. It has an app, but just having an app isn't good enough. It has to compete with Starbucks' app of course.
More importantly, Dunkin's path to delivering more speed to customers is really through its next-generation stores. Investors want to see those stores open as soon as possible. Those new stores are currently estimated by management to represent $130 million of the company's revenue in 2019. That would represent less than 10% of total revenue for this year.
Dunkin's U.S. chief operating officer Scott Murphy told TheStreet back in September the opening of the new stores would easily be a multi-year process.
The 'X' Factor
The 'x' factor is, of course, that lower-priced brands tend to steal some market share in rough economic environments, which means Dunkin' could see a slight pop in sales growth in the next few years, while Starbucks may have trouble sustaining that golden 4% U.S. sales comps growth rate.
Essentially, negative changes in the economy could cause Dunkin' to have more upside surprises for sales, and more downside surprises for Starbucks.
What's even worse for Starbucks, is that if former Chairman and CEO Howard Schultz runs for president, it's possible that millions of customers could stop going to the stores. Some Democrats are angry about Schultz's plan to run for president, and have threatened to essentially boycott the chain, which could cause a considerable loss of revenue for the company.
On the cost side of the equation, rising wages due to a tight labor market, with unemployment hovering around 4%, is a risk to the operating margins of both of these companies.