With 41,198 locations as of Sept. 30, McDonald's (MCD -0.01%) is an absolutely massive fast-food operation. But apparently it's not big enough yet. The company is launching a secretive coffee chain in Bolingbrook, Illinois, just outside of Chicago. And this news might rattle shareholders of Dutch Bros (BROS -0.90%) and Starbucks (SBUX -0.41%).
The coffee-centric concept is called CosMc's -- named after an alien from McDonald's lineup of characters from the 1980's. It was first mentioned by McDonald's CEO Chris Kempczinski in the company's conference call to discuss financial results for the second quarter of 2023. But people have since spotted a location being built in Bolingbrook, giving them a peek at the McCafe-inspired menu.
According to pictures on social media, the menu for CosMc's will be centered on beverages such as teas, lemonades, frappes, lattes, coffee, and more. However, there appears to also be a food menu, which includes items directly from McDonald's, such as McMuffins.
In Q2, Kempczinksi said CosMc's will be a "Small-format concept with all the DNA of McDonald's but its own unique personality." This small-format concept, however, will apparently attempt to drive high sales volume by optimizing for drive-thru. Pictures on social media appear to show four drive-thru lanes at the test location.
McDonald's is as experienced as any restaurant company when it comes to the drive-thru. And since CosMc's is essentially borrowing from McDonald's, it has experience with the menu as well. Therefore, it seems CosMc's has a high probability of finding a measure of success.
That said, here's why Starbucks shareholders and Dutch Bros investors shouldn't worry about CosMc's.
What investors should watch
Capitalism invites competition. Every business around today has outcompeted rivals to an extent to get where it is. And each fends off competitors on an ongoing basis. Investors naturally worry about increased competition. But the stock market is littered with overreactions in the past.
For example, there was a time that Chipotle Mexican Grill was growing and developing other restaurant chains. This included selling burgers and milkshakes with a concept called Tasty Made, which it's since shut down. It still owns Pizzaria Locale. But Chipotle hasn't grown that concept either over the last decade. And Chipotle certainly didn't put any major fast-food players out of business, despite concerns from shareholders of other companies.
Etsy shareholders were likewise worried when Amazon began experimenting in handmade products. But Etsy has continued growing nonetheless.
For shareholders of Dutch Bros and Starbucks, there's no need to worry about CosMc's from McDonald's for now. Even if tests are successful, there will likely still be very few locations five years from now, meaning it shouldn't impede growth for these other two chains. Shareholders, therefore, should keep their eyes on the investment thesis for each company.
Dutch Bros
For Dutch Bros, the investment thesis is fairly straightforward. The key question is can it go from being a successful regional coffee chain of less than 800 locations to a successful national chain of about 4,000 locations? The gross margin at the company-owned-shop level is about 24%. Therefore, if it can expand beyond its core markets, maintain strong profitability, and keep corporate-level expenses in check, Dutch Bros could be a good, long-term investment.
Starbucks
For Starbucks, finding market-beating upside is more complicated given the size of its empire. It has over 38,000 locations worldwide but wants to expand beyond 50,000 locations long term. A key growth market for the company has been (and will be) China. But that market has underperformed for the company for a long time.
In the quarter that ended on Oct. 1, Starbucks had revenue of $840.6 million from its 6,806 locations in China. In the same quarter of 2019, before the pandemic, the company had revenue of $763 million from just 4,125 locations. In other words, Starbucks has increased its locations in China by 65% over the last four years. But revenue is only up 10%.
Plus, the company's locations in China aren't generating the sales volume that they were. This leads to lower profitability and it's something to be concerned about. If volume can rebound, then this could be a powerful catalyst from Starbucks' profits. But it's unclear what's holding back sales this far removed from the pandemic.
Looking to the future
In closing, coffee investors should keep an eye on CosMc's because it could impact the competitive landscape someday. But that day could still be a decade away, if it comes at all. In the meantime, coffee chains such as Dutch Bros and Starbucks can still create value for their shareholders.
For investors wondering what CosMc's could mean for a McDonald's investment, management should lift the veil of secrecy surrounding the concept in an investor presentation scheduled for Dec. 6.