Coffee is hot, and not just because of its temperature. It's become a billion-dollar industry, in no small part because of giant Starbucks (SBUX 0.18%), which turned your average cup of Joe into a statement drink. Starbucks has been a great investment, gaining more than 250% over the past 10 years. But it's been facing challenges lately.
In the meantime, newcomer Dutch Bros (BROS 0.40%) has burst onto the scene, posting impressive growth despite a pressured environment. It's a much smaller operation than Starbucks and doesn't pose a real challenge (yet) to the king of coffee, but it sees enormous growth opportunities. It's also been popular with investors, gaining 6% since it debuted on the stock market last September, while Starbucks stock has fallen 26% over the same period.
But which one of these is the better buy today? Let's see.
The undisputed industry leader
Starbucks has such a strong grip on coffee that it would be very hard to unseat it anytime soon. Its sheer size -- nearly 35,000 stores and growing -- gives it dominance in the industry. But beyond that, it has a growth-oriented culture and strives to be agile and adaptive to changing trends. While its bulk weighs it down somewhat, it responded quickly to shifting patterns during pandemic lockdowns and adapted accordingly, removing some of the edge from what could have been a disastrous situation.
It has emerged as a stronger company, with improved services such as an upgraded mobile platform and curbside delivery in many locations.
Despite its ubiquitous global presence, Starbucks is still opening stores at a quick pace. It opened 318 stores in the 2022 third quarter (ended July 3), and anticipates operating 55,000 stores by 2030, possibly becoming the largest restaurant chain on the planet.
It's efficiently increasing sales and pulling in profits throughout most of its empire. Sales rose 9% in the third quarter, with a 3% increase in comparable sales (comps), despite a 44% decline in comps in China, its second-largest market. Margins were pressured and profits decreased year over year due to rising costs and supply chain issues, and that will likely remain for the near future.
On other fronts, Starbucks is dealing with two critical issues: finding a new CEO after Kevin Johnson's departure, and workers unionizing. Howard Schultz is back for his third stint as CEO in an interim role while the company conducts a search -- and without a long-term leader, its future is uncertain. As for unionization efforts, it may change how things operate, adding another source of uncertainty right now.
Starbucks pays a growing dividend that yields 2.3% at the current price, which is an incentive to own the stock.
The new kid on the block
I like to emphasize that Dutch Bros is not competition for Starbucks and shouldn't be evaluated that way, although in the distant future that could change. It has a differentiated model in its "fun-loving, mind-blowing" culture, and although more than half of the shops are company operated, it also has franchises.
Dutch Bros is a West Coast-based coffee chain with just over 600 coffee shops in 14 states, up from 12 states just three months ago. It's opening stores quickly relative to its size, with 31 new stores in the second quarter, and plans for 130 total for the full year.
New stores are particularly important, since they're providing all the revenue growth. Sales increased 44% in the second quarter, which sounds -- and is -- impressive, considering the pressured macroeconomic environment. However, comps decreased 3% in the quarter, and management expects comps to be flat for the full year. It's experiencing the same customer pocket-watching as many other retailers, but that appears to be a short-term challenge that doesn't speak to the company's long-term potential.
Dutch Bros has a huge market opportunity as it opens new stores and moves into more central states. It sees the possibility for 4,000 stores over the next 10 to 15 years, and there may be a lot more than that in the years beyond.
In the meantime, though, its main challenge is becoming profitable, and increased costs are only making it harder. Although Dutch Bros has been raising some prices to meet those costs, the company-operated contribution margin (or the amount of money each store makes after accounting for variable costs) shrank from 32% last year to 24.6% in this year's second quarter. Adjusted earnings before interest, taxes, depreciation, and amortization fell from $31 million in the year-ago period to $24 million in Q2 2022.
Which is the better coffee shop stock?
Starbucks historically has been a great stock to own, but it's dealing with major challenges. Despite that, it's operating efficiently and demonstrating strong growth. Shares are trading around 24 times trailing 12-month earnings, an average historical valuation for the stock.
Dutch Bros is posting high growth and sees the opportunity for a chain that's almost seven times its current size. Wall Street sees the potential for a stock price that's 30% higher than it is currently.
For dividend investors, Starbucks is still a great choice, and I think that Starbucks will get over its current issues and continue to be a strong performer. However, in the current market, Dutch Bros looks as if it has an advantage over Starbucks because of its growth opportunities.