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Forget Starbucks, This Growing Coffee Chain Is Ready To Explode

 February 20, 2013 04:05 PM

I'll never forget my first visit to Starbucks (NYSE: SBUX). Many of my friends were talking enthusiastically about this fancy new coffee shop from Seattle that had just opened in the neighborhood. When I saw the prices and the strange names of the beverages, I nearly fainted in surprise. Heck, I could buy an entire meal at McDonald's (NYSE: MCD) for the price of one of Starbucks' drinks.

Not to mention, it had the nerve to name a small cup of coffee, "Tall." Strange words such as "Venti" and "Frappuccino" quickly became part of yuppie culture and then rapidly spread to all demographics, as Starbucks grew into the behemoth brand it is today.

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Soon, paying up to $5 for a cup of coffee became acceptable. This fact alone proves the amazing marketing machine of Starbucks.

There is no doubt this company has become the undisputed king of coffee shops. But cracks are starting to show in its armor.

The bar has simply been set too high for this thriving brand. Despite the company's soaring profits, global expansion, aggressive acquisitions and immense popularity, it failed to meet fiscal first-quarter revenue expectations. During the 2013 fiscal first quarter (ended December 2012), Starbucks earned a little more than $432 million, with revenue of $3.8 billion, just short of the $3.85 billion analysts were expecting.

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I realize that's not much of a miss, but it illustrates the point that the company must continually and aggressively reach higher to keep up with expectations.

Stocks are anticipatory mechanisms, meaning prices move on anticipation of the future. When things actually occur, the price often moves in the opposite direction than expected. This phenomenon is also known as the "buy the rumor, sell the news" effect. This is why I believe this stock has already expanded beyond its highest expectations and the top is in or very near.

The technical picture supports this view. Shares have fallen off its highs of $57 and have broken the 50-day simple moving average on the downside. Based on the technical picture, combined with potentially impossible high expectations, I think shares of Starbucks will have a difficult time pushing much higher.

This means current and future investors may want to look elsewhere for profits in the coffee shop niche.

This is where Dunkin' Brands Group (NYSE: DNKN) comes in.

Investors who want exposure to the coffee-house craze have a better chance of making profits with this stock. Here's why...

 1. Relatively new IPO

Believe it or not, the long-time and successful Dunkin' Brands is a relatively new stock. After going public with a $420 million-plus initial public offering (IPO) in July 2011, the company is still riding on the freshness of the shares.

2. Franchise structure lessens debt worries

The No. 1 item Dunkin' sellers mention is the high debt level of the company. It's no laughing matter that interest on the company's debt is expected to be more than $60 million this year. But this fact is mitigated by the franchise expansion structure of the brand. When the company expands, the costs are carried by the individual owner of the particular Dunkin' Brand store. This means the heavy debt load shouldn't affect expansion plans nearly as much as it would in a company not reliant on franchises to grow.

3. International expansion

While Starbucks is already established in multiple international locations, it's lost its uniqueness in many markets. Dunkin' Brands could reignite the coffee experience as it expands globally. The company recently announced a franchise agreement with Vietnam Food and Beverage Co. Ltd to assist in building the brand in Vietnam.

The company has more than 10,000 locations in 32 countries today. In 2012, aggressive international expansion started with moves into India and Guatemala, as well as growth in existing markets such as Germany, Chile, Colombia and the United States with an expansion into Southern California. The United States accounts for 75% of the company's revenue and more than 80% of its profits. As international expansion catches on, I can only see revenue and profits climbing higher.

4. Climbing dividends and strong performance

If you follow Elliott Gue's Top 10 Stocks, then you probably understand the importance of increasing dividends. Simply put, one of the best ways to maximize your returns is to invest in businesses that have a record of raising dividends.

Dunkin' Brand just raised its quarterly dividend by 4 cents to 19 cents a share, representing a 27% increase compared with fourth-quarter 2012. Revenue climbed 6.1% and adjusted operating income added 15.3% on a 52-week basis in 2012. Earnings per share soared 38% to $1.28 year-over-year.

5. New products

Dunkin' launched more than 30 new products during 2012 and tested 40 unique new items in various markets. This continual innovation will likely result in new, high-profit items becoming standard fare within the chain.

6. Strong technical picture

Dunkin's stock price has been climbing higher since mid-November 2012. It is well above the 50- and 200-day simple moving averages, and supported with a solid upward sloping trend line.

Risks to Consider: Anything can and does happen in the stock market. No one knows the future and no matter how strong a company looks, things can quickly change. Always position size properly and use stops when investing.

Action to Take --> Dunkin' Brands is a good buy right now in the $37-38 range with a $45 18-month target.

-- David Goodboy

P.S. -- StreetAuthority Co-Founder Paul Tracy recently put together a report, "The Top 10 Stocks for 2013." He's identified 10 stocks that have a good track record of raising dividends. During the past five years, these 10 stocks have returned 87%... despite a flat market. This includes one stock that's gained 137% in three years... another that's raised its dividend 463% since 2004... and another that has more than $9.21 per share in cash (nearly half of its share price). To learn more about the Top 10 Stocks for 2013, visit this link.

David Goodboy does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of SBUX in one or more of its "real money" portfolios.


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