Searching for a growth stock in the food industry? It's never been tougher to do. While Amazon's purchase of Whole Foods is already putting pressure on the grocery industry's razor-thin margins, the fast-casual niche has had an awful run lately as well.
Historically, Starbucks (NASDAQ:SBUX) has been able to buck the trend -- returning over 1,400% between early 2009 and mid-2015. But the times are a-changing, and things don't look so good for Starbucks. That's why I believe growth investors would do better to put their money behind GrubHub (NYSE:GRUB). Yes, the company behind that delivery app you pull up when going out seems like too much of a task.
Millennials love the concept, but not big names
It's hard to believe, but back in the early 1990s, coffee houses weren't really a "thing" in the United States. Sure, Dunkin' Brands offered a place to get your caffeine -- as did most restaurants -- but the idea of a "third place" to gather outside home and work was completely foreign.
Perhaps that's why -- according to Statista -- there were only 1,650 independent coffee houses in America in 1991. But then, former Starbucks CEO Howard Schultz took a trip to Italy, realized the cultural significance of coffee houses and a gaping hole in America's social landscape, and used his coffee houses to fill it.
That approach, and the consistency behind the experience of the brand, made Starbucks a wildly popular option for over 20 years. You knew exactly what you could get there, and the ambiance made it a unique option for a meeting place.
But with that success came copycats: between 1991 and 2015, the number of independent coffee houses increased 1,900% to over 31,000 locations nationwide.
And that's bad news for Starbucks. Here's why: As former hedge-fund manager Mike Alkin pointed out in a January conference, millennials are becoming the dominant consumers, and they're looking for three things when it comes to their goods:
- When possible, that it is organic.
- That it is made or sourced by local means.
- That it comes from a small vendor.
Critically, millennials are willing to pay up for such things. While Starbucks can certainly offer its fair share of organic coffee, the chain -- by its very definition -- isn't "local" or "small." That's where the 31,000 other coffee stores come into play.
In the world of investing, the most important thing to examine is a company's moat, or sustainable competitive advantage. Starbucks' key moat -- as well as for most other consumer products -- is its brand. Sadly for the company, that brand is losing its power stateside. Nowhere is that more obvious than in the company's comparable-store sales (comps). As you can see below, were it not for price increases, worldwide comps would actually be negative right now.
To an extent, falling comps are to be expected when a company reaches Starbucks' size. But the fact that traffic in the store has gone negative is a telling sign that the company's brand -- its only real moat -- may not be as strong as some believe.
If the stock were trading in a reasonable range, that would be OK. But as it stands right now, shares trade for 26 times free cash flow, which is a growth stock valuation for a company that is demonstrably -- in terms of comps -- having trouble with growth.
The key that makes GrubHub a better growth choice
You might look at GrubHub and think: "It doesn't do anything special. At least Starbucks makes something."
And you wouldn't be wrong. But the difference between Starbucks and GrubHub moving forward comes down to one thing: GrubHub has a much more powerful moat: the network effect. Namely, as more people join a platform, the platform becomes stronger.
GrubHub's value proposition is simple: It offers a way for restaurants to streamline their carryout and delivery service, without needing to hire IT experts or invest in the technology to do so in-house. It also offers delivery services in select markets.
But the bottom line for investors is this: Ihe more customers join GrubHub, the more restaurants are incentivized to join the platform. And the more restaurants that join the platform, the more customers are incentivized to join. It's a virtuous cycle. And as you can see below, the network effect is in full swing.
Granted, some of this growth has come via acquisition, but it only further cements GrubHub's leading position and the strength of its network effects. But here are some other achievements to chew on that occurred over the same time frame:
- The number of restaurants listing on GrubHub has more than doubled, from 30,000 in 2013 to over 85,000 today.
- The number of daily average orders has nearly quadrupled, to 430,000 in the most recent quarter.
To be sure, GrubHub has a growth stock's valuation -- trading at 73 times trailing free cash flow. Unlike Starbucks, however, GrubHub's underlying business is growing like a growth stock -- the company posted year-over-year revenue growth of 50% last quarter. As the company locks up more and more restaurants and customers, it will gain leverage and pricing power -- something that can have magical effects on compounding investor returns.
While I don't yet own shares of GrubHub, it's on my short list of potential buys. I've already given the company an outperform rating on my All-Star CAPS profile (and given Starbucks an underperform rating). I think if you're looking for growth stocks in this industry, the power of GrubHub's network effect makes it an excellent choice. Those millennials can still buy from their small, local, organic restaurants using GrubHub; increasingly, that's an important dynamic.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Brian Stoffel owns shares of AMZN. The Motley Fool owns shares of and recommends AMZN and Starbucks. The Motley Fool recommends DNKN. The Motley Fool has a disclosure policy.