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Is There Still Time to Buy Starbucks?

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Starbucks (NASDAQ: SBUX  ) has delivered truly extraordinary gains for investors over time. However, market saturation could become a problem as the company grows in size, and competition from players like McDonald's (NYSE: MCD  ) and Dunkin' Brands (NASDAQ: DNKN  ) is an important risk to monitor. Does Starbucks still offer upside potential, or is it too late to invest in the company?

The risks
Starbucks has built a global empire comprised of 20,519 stores around the planet as of the end of the first quarter, and the company has reached a considerable level of market penetration in big markets such as the United States. Growth tends to naturally slow down as companies become bigger and more mature over the years.

Besides, success attracts competition, and different players are after Starbucks and its profitable leadership position in the specialized coffee business. Fast-food giant McDonald's is facing serious difficulties lately, especially when it comes to generating growth in the U.S., so the company is going back to basics in order to improve customer experience and product quality.

Source: Starbucks.

McDonald's is planning to refocus on strategies that have produced solid results for its McCafe business in the past. According to President and CEO Don Thompson:

So I think the McCafe aspects, what we can do better around McCafe beverages is going back to really some of the implementation strategies when we began this in 2007, 2008, 2009, which was focus on that base coffee and you are seeing that in the U.S. businesses, you have big focus around coffee quality, base quality, reintroducing customers to our McDonald's coffee. We have and sell the most drip coffee in the U.S. We have to reintroduce customers to that. And I think that's very important so we focused on that this year in the U.S.

Dunkin' Brands is materially smaller than Starbucks, but the company is planning to continue expanding at a rapid peace, especially when it comes to its Dunkin' Donuts division. Dunkin' Brands expects to add between 380 and 410 net new Dunkin' Donuts restaurants in the U.S. during 2014, representing more than a 5% growth rate in the store base.

Over a longer time frame, Dunkin' Brands estimates it has enough room for nearly 15,000 Dunkin' Donuts locations in the country, almost double its current store base.

The half-full cup of coffee
Competition is always a risk for successful companies, and Starbucks is no exception. McDonald's and Dunkin' Brands are just two of the many competitors to watch, as Starbucks will most likely continue facing growing competitive pressure from multiple players in the future.

However, Starbucks benefits from tremendous brand power, a unique cultural footprint, and a differentiated customer experience. While McDonald's, Dunkin' Brands, and others compete aggressively in the low end of the pricing spectrum, Starbucks is uniquely positioned in the premium segment due to its extraordinary pricing power.

Source: Starbucks.

The business is truly firing on all cylinders, indicating that there is little sign of market saturation or damage from the competition. Even in the U.S., where Starbucks has reached a significant level of market penetration, same-store sales increased by a vigorous 6% during the quarter ended on March 30, a very encouraging sign when it comes to evaluating demand strength in main markets.

Total sales in the Asia-Pacific region jumped 24% to $265.3 million during the quarter on the back of 699 net new store openings and a 7% increase in comparable-store sales. Considering recent performance, it looks like Starbucks has a lot of room for store base expansion in emerging markets.

In addition, recent acquisitions like Teavana, Evolution Fresh, and La Boulange provide a deep pipeline for product innovation in the coming years, both in terms of food and drink offerings.

Starbucks is also venturing into specialized sodas, and management is quite optimistic about the possibilities for growth in its evening menu, which includes wine and beer in combination with more sophisticated food items. Besides, packaged products are a smart way to leverage the brand and expand into different sales channels and product categories.

Starbucks has a successful multilayered growth strategy that relies on a combination of store base expansion, innovation, and new sales channels, so the company still has plenty of room for growth in the years ahead.

Foolish takeaway
Generating growth tends to be harder as companies become bigger over time, and competitors such as McDonald's and Dunkin' Brands are relevant risks to monitor. However, Starbucks has rock-solid competitive strengths, and the company is capitalizing on its opportunities for growth via multiple venues at the same time. This steaming-hot growth company still offers considerable room for gains.

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Andrés Cardenal

Andres Cardenal, CFA is a tenacious researcher of the best investment opportunities around the world. Andres is an economist and CFA Charterholder living in Buenos Aires, Argentina. Naturally flavored. Follow me on Twitter for more investment ideas:

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8/28/2015 4:00 PM
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