Starbucks May Leapfrog McDonald’s in Market Value

THURSDAY, MARCH 20, 2014
Starbucks May Leapfrog McDonald’s in Market Value
By JACK HOUGH | MORE ARTICLES BY AUTHOR
McDonald’s has been an excellent long-term investment. However, the struggling chain could see its market value eclipsed by Starbucks.By the end of the current bull market, McDonald’s (ticker: MCD) might no longer be America’s largest restaurant by market capitalization.
Starbucks (SBUX), now valued at $57.4 billion, would need to rise 66% to match McDonald’s $95.1 billion market cap. If recent trends hold, that could happen within a few years. Over the past year, Starbucks has surged 32% while McDonald’s has slipped 3%.
McDonald’s has been America’s largest restaurant operator by market value since at least the 1970s, although the closely held Subway sandwich chain surpassed it in store count in 2011.
McDonald’s shares have split seven times since their 1965 debut. An investor who picked up 100 shares during the initial stock offering paid about $2,250. Had he held until the end of 2012, he would have amassed 74,360 shares worth $6.6 million, according to the company.
McDonald’s astonishing long-term success stems from countless menu and service innovations that have helped it vie for customers in all income groups during all meal times, and in between, across much of the world.
Results have slowed, however. During the fourth quarter of last year, the company generated flat sales and earnings. Last month, same-store sales, a key measure of improvement at longstanding locations, fell for the fourth straight month. Management says it is working to improve value and streamline menus. Some analysts say McDonald’s weathered a deep U.S. recession by heavily promoting its Dollar Menu, which brought in more lower-income customers, who are now struggling amid a widening U.S. wealth gap.
Meanwhile, Starbucks in January said revenues for its first fiscal quarter, which ended Dec. 29, surged 12%. Earnings per share jumped 25%. Same-store sales improved by 5% on a 4% increase in traffic.
There could be plenty more growth ahead. Starbucks plans to test a new ordering system this year that will let customers pay from their mobile phones and predict their arrival time at stores. If successful, it will greatly reduce waiting times during peak hours. Management calls it a potential “holy grail” for driving better sales results, and hopes to roll it out next year.
After some misfires on breakfast menu items like egg sandwiches, Starbucks has had success with La Boulange Bakery pastries, Teavana teas and handcrafted sodas. It’s testing evening offerings of wine, beer and gourmet snacks in some markets. It already sells private-label brewed coffee through other restaurants and beans and grounds in grocery stores and as K-cup single serve packs.
It will be many years before Starbucks catches up to McDonald’s on profits. Starbucks is expected to earn just over $2 billion during its current fiscal year, which runs through September. McDonald’s is projected to earn $5.7 billion in calendar 2014. But investors are currently paying unusually large premiums for companies that are perceived to have plenty of growth potential. Starbucks goes for 28.5 times estimated earnings for its current fiscal year, versus 16.5 times for McDonald’s.
Wall Street expects Starbucks to increase earnings per share by close to 20% a year for years to come, more than twice as fast as McDonald’s. Starbucks, with about 20,000 stores worldwide, can also open new shops with much less space than McDonald’s, which has roughly 35,000 stores. Starbucks plans to accelerate new store openings in the U.S., including an eco-friendly design that consists of a few repurposed shipping containers staggered to create a drive-through.
What could stall Starbucks in its race to pass McDonald’s? A market downturn could torpedo stocks with lofty valuations. A return to recession, or a shift in income distribution, could make consumers scale back on pricey lattes. Or McDonald’s could come up with a new growth driver. After all, it once owned Chipotle Mexican Grill(CMG), the hottest restaurant on the U.S. stock market, with shares fetching 46 times earnings. Analysts say the burrito chain, whose shares have multiplied more than 10 times in value in eight years, could double its store count from here, and find success with new concepts, like pizza. Chipotle today has a stock market value of about $19 billion. Perhaps McDonald’s has another Chipotle in its playbook—and won’t sell too early this time.
If Starbucks does eclipse McDonald’s in market value in coming years, it will come with a footnote. Dividends shift funds from a company’s balance sheet to investor pockets, and so represent a portion of potential stock market value that has been sliced off and returned. Starbucks, which yields 1.4%, began paying dividends only in 2010. McDonald’s, which yields 3.3%, has been making—and raising—payments since 1976. Over the past decade alone it has paid out around $20 billion.