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Starbucks' (NASDAQ: SBUX ) enormous success prompted McDonald's (NYSE: MCD ) and Dunkin' Brands Group (NASDAQ: DNKN ) to enter the specialty coffee market. Now, its success serving tea and chocolate-based beverages is driving another wave of copycat beverages. Growing demand for tea and chocolate provides an opportunity for all three companies to increase beverage sales, but one company is positioned better than the other two.
Americans are going crazy for tea
U.S. demand for tea is soaring. According to the Tea Association of the USA, the size of the U.S. tea industry grew from a mere $1 billion in 1990 to $10 billion at present -- a 10.5% compound annual growth rate. The industry is expected to grow another 30% by 2017.
So it is no surprise that Starbucks, McDonald's, and Dunkin' Brands have eagerly rolled out their own teas. Starbucks owns two major tea brands: Tazo and Teavana. McDonald's serves iced tea and sweet tea. Dunkin' Donuts serves hot tea and iced tea in its stores and packaged tea through retailers.
Though McDonald's and Dunkin' have made an effort to join the tea craze, neither even comes close to Starbucks' exposure to the booming market. Chief Executive Howard Schultz said Starbucks would "do for tea what [it] did for coffee." These are bold words considering Starbucks almost single-handedly created the specialty coffee craze, but it is far from impossible.
When Starbucks CFO Troy Alstead sat down with Motley Fool CEO Tom Gardner, he talked about the complementary nature of coffee and tea. He said coffee is a morning beverage that people grab quickly on their way to work, while tea is an evening beverage that people savor and take longer to drink. By adding tea to its locations, Starbucks can boost its afternoon and evening sales.
Teavana can also stand on its own. There are now 325 Teavana stores, and Starbucks plans to add another 1,000 over the next five years. Only 8% of Starbucks' revenue comes from tea, whereas 75% comes from all beverages, so the Teavana expansion could serve as a dramatic boost to Starbucks' growth.
Tea offers more than just a revenue boost -- it also offers fat margins. Most tea is priced at 3.5 to 5 times the wholesale price, implying a 71% to 80% retail margin. Teavana's gross margin was more than 60% when Starbucks bought it, even higher than Starbucks' high-50s gross margin.
The combination of increasing demand driving top-line growth and large margins allowing most of the revenue to fall to the bottom line makes tea a must-have for Starbucks, McDonald's, and Dunkin' Brands. But there is one other trend that Americans are falling for...
Everyone loves to drink chocolate
Walk into any chain that boasts a wide beverage selection and you are bound to find a chocolate drink on the menu. Starbucks offers 12 drinks that feature chocolate as an ingredient, including the White Chocolate Mocha, White Chocolate Creme Frappuccino, and Chocolate Chai Tea Latte. McDonald's is not shy about adding chocolate to its beverages, either. It features five drinks with chocolate in their names, and many more have the ingredient drizzled on top. Dunkin' Donuts offers hot chocolate, mint hot chocolate, and salted caramel hot chocolate.
As in the tea market, Starbucks is in the best position to take advantage of the gourmet chocolate beverage market. Although not nearly as large as the tea industry -- IBISWorld estimates the size of the U.S. drinking-chocolate market is $840 million and growing at less than 2% per year -- gourmet chocolate beverages are a good fit for Starbucks' customer base.
Like coffee beans, cocoa beans vary in taste and quality depending on where they are harvested. Chocolate drinks can also be custom-blended to emphasize the cocoa flavor or the sweetness of the chocolate sauce. Chocolate also contains antioxidants that improve our health and it undoubtedly improves our moods. The combination of healthful ingredients with customizable options makes gourmet chocolate beverages an unappreciated growth opportunity for Starbucks.
Thanks in large part to Starbucks, Americans are going crazy for specialty beverages. Specialty coffee has already gone mainstream; lowbrow chains like McDonald's and Dunkin' Brands have rolled out their own popular coffee for price-conscious consumers. Now, tea is set to take the country by storm. Starbucks is, once again, leading the way, with McDonald's and Dunkin' Brands offering their lower-priced versions. Finally, specialty chocolate beverages could be the next next big thing, though they will stay in the background for now.
No matter how you slice it, Starbucks is leading all the major specialty beverage trends. If it can stay in front, Starbucks' rich stock price may be justified.
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