Starbucks vs. McDonalds
Disclosure: Trent owns SBUX.
The comparison of Starbux (SBUX) to McDonald’s (MCD - Annual Report) when assessing Starbuck’s potential is one we have used often. We were pleased to see the method used by Douglas McIntyre (via SeekingAlpha.) He presents the case well, so definitely read his article for the jist. We will just make a few comments below on certain points. Douglas says:
At the company’s current revenue run rate, with 12,000 stores, the revenue yield per store would be $633,000. McDonald’s (NYSE:MCD) currently has nearly 32,000 stores, up from 23,000 ten years ago. McDonald’s revenue for 2005 was $20.46 billion, or $639,000 per store.
So, it is not unfair to ask if coffee is as popular as hamburgers. The answer may well be yes.
Not unfair indeed. But the correct answer is that coffee is clearly more popular than hamburgers. Most coffee drinkers do so daily, perhaps several times daily. Hamburger eating tends to be less frequent even among regulars. By comparing the revenue per store Douglas is ignoring the fact that Starbucks stores are smaller on average than McDonalds. They are generating the same revenue from a smaller space, which is more efficient. We at Stock Market Beat believe the number of McDonald’s stores is merely a minimum potential penetration level for Starbucks rather than the ultimate goal. Perhaps matching McDonald’s total square footage would be a more appropriate target.
At $38.79, the stock is just shy of its all-time high. It’s market cap is $29.6 billion.
We were a bit surprised to see that Douglas did not continue the McDonald’s analogy here to indicate a potential future value for SBUX, which could then be discounted back to today’s price to estimate the return an investor will see. But first we need to correct one small error Douglas appeared to make.
When the company announced its Q2 earnings (fiscal Q2 ending April 2, 2006; see conference call transcript), it stated that its goal was to open another 1,800 new stores globally by the end of the year. That would get them over 12,000.
Actually, the conference call transcript says that the 1,800 is the full-year goal, rather than what is expected over the remainder of the year. To round off, we will assume the company can open 2,000 new stores annually in order to reach 30,000 stores in approximately 10 years. Taking just the simple McDonald’s comparison, SBUX should be able to grow its enterprise value from $29 billion today to $49 billion in 10 years. That gives an uninspiring 5.5% growth rate over those 10 years.
However, as we pointed out, SBUX is more efficient than MCD, which is reflected in a 20.8% ROE for SBUX compared to 17.7% for MCD. And MCD has debt funding which boosts its ROE. As growth slows at SBUX it too could add some debt to its mix to generate better returns for equity holders. But at any rate, the 3 per cent differential in ROE says that SBUX should be more valuable than MCD when it finally tops out. Looking up the fundamental P/E calculation on p. 192 of Analysis of Equity Investments: Valuation, we can get a good starting point. If we adjust the payout ratio to give us the same implied growth rate and required return for Starbucks as we currently have for MCD, we find that SBUX would deserve a 23.2x P/E multiple rather than the 17.3x that MCD has today. And assuming further that SBUX achieves the same debt/equity mix it could justify a $66.5 billion enterprise value. If we get there the average annual return would be more like 8.5 per cent, which is a good deal better but still may not justify the price now unless one is willing to bet that SBUX can, indeed, grow to a larger size than McDonalds (or if one assumes the average return on other investments will be less than that.)
At any rate, there is no correct answer. We will know 10 years from now, and not a day sooner, what Starbuck’s price will then be. Hopefully, though, this discussion serves as a useful launching point for your research.
Disclosure: Author is long Starbucks (SBUX) at time of publication.
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Some anecdotal ramblings below…
I think something is missing in the analysis here. There is no recognition that as McDonalds spread into emerging markets, revenue per store has dropped. Starbucks has nowhere near the global presence and penetration that McDonalds has. A McDonalds in India or Russia is simply not going to generate as much revenue as a McDonalds in North America. During my university days 8 years ago, I used to be a manager at a moderate volume McDonalds restaurant in a suburb of Vancouver, BC. We could sometimes take in $1800 in a lunch hour with 15 crew working. Average daily revenue was approximately $7000. This works out to over $2 million per year. I know that we were close to the Vancouver full size restaurant average. The busiest stores would bring in $4+ million per year. I can’t imagine any individual Starbucks locations bringing in this much revenue.
So my point is, that as Starbucks penetrates markets like McDonalds has, average revenues will drop in the same fashion, affecting growth. Also the efficiency gap you mention will not be as large if you compare store performance within markets as opposed to looking at global numbers.
Craig,
Thanks for the comments. Agreed that comparing McDonalds to Starbucks is to some extent apples to oranges. I just find it to be a useful starting point for developing an investment thesis. You certainly wouldn’t want to buy the stock (or any other) based on one analysis.
I disagree, however, that the efficiency advantage is ephemeral. A cup of coffee will always take less time, expense and labor than a similarly priced burger. Unless you can increase the number of turns by an even larger rate the efficiency differential just is what it is.
And with average store sales in the $630,000 range (it is closer to $1 million for company-owned stores) I bet there is at least one doing $4 million somewhere.
One thing that should be taken into consideration is that Coffee is a universal drink. It is the number one consumed beverage in the world. McDonald’s hamburgers are not necessarily popular in China and India.
– Faisal Laljee
Faisal – thanks for your comment. There are definitely parts of this analysis that favor Starbucks and others that favor MCD. Really I think it is just a creative way to take a fresh look that hopefully spurs other lines of thought.
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