It's officially Fall, especially for Starbucks (NASDAQ:SBUX), as September 3 marked the launch of its seasonal espresso drink: the Pumpkin Spice Latte—or PSL to the diehards. Investors, too, may be in for an annual autumn treat—a quarterly dividend increase. Yes, an announcement of a dividend increase might make headlines sizzle and cause a one day surge in share price, but for Starbucks investors, is dividend growth even a worthwhile factor to consider right now?
A long history of annual dividend increases certainly makes a company attractive to investors, but Starbucks only has a three year history of dividend increases with a current dividend yield of 1.10%. This limited history clearly isn't complete enough for some investors, but let's take a deeper look.
The Ultimate Java-Off: Starbucks versus Dunkin'
Naturally, a company's dividend is first compared with its competitions'. Starbucks' dividend yield initially appears to be on point with its competitor Dunkin' Brands Group (NASDAQ:DNKN), which pays out a dividend yield of 1.72%, but in actuality, these payouts are worlds apart. The trick is to look at the payout as a percentage of operating cash flow. When dividend growth is viewed from this angle, Starbucks' dividend becomes a worthwhile factor to consider when differentiating Starbucks from its competition.
In 2012, for example, Dunkin' Brands total dividend payout was 45% ($70 million) of the company's operating cash flow of $154 million, as compared to Starbucks' total dividend payout at 29% ($513 million) of the company's operating cash flow of $1.75 Billion. This lower payout percentage tells us that Starbucks retains more cash than Dunkin' Brands and is in a better position to provide future dividend increases and use this cash for expansion. But to determine which of the two companies is actually using this retained cash for growth, investors must delve into each company's cash flow statements.
A closer look shows that Starbucks spent $1.1 Billion on capital expenditures over the last year while Dunkin' Brands only spent $25 million. Placing these numbers in perspective, Starbucks' spent 42% of its operating cash flow on capital expenditures and Dunkin' Brands spent 18%. However, Dunkin' Brands is a franchise-based business model, whereas Starbucks franchises on a very limited basis, primarily through its Seattle's Best Coffee brand.
The franchise model allows growth for Dunkin' Brands without the costs associated with opening company-operated stores. This growth, however, may be more time consuming for Dunkin' Brands, as they will have to coordinate their domestic expansion throughout the western US with franchisees. Dunkin' Brands even reports that the first stand-alone restaurants are not expected to open in Los Angeles until 2015. By that time Starbucks might have reached its FY2014 target of 1,400 net new stores and generated even more fans of its famed Pumpkin Spice Latte. This more immediate expansion coupled with Starbucks' favorable retained cash position makes Starbucks the clear winner of this java-off.
The Grass is Greener with Green Mountain Coffee Roasters
Investors impressed by Starbucks' retained cash position will be stunned by the 218% year-over-year increase in free cash flow that Green Mountain Coffee Roasters (UNKNOWN:GMCR.DL) reported last quarter. Free cash flow is what is left over after a company's expenditures for growth and is calculated by subtracting capital expenditures from operating cash flow.
So far in 2013, Green Mountain Coffee Roasters has been able to reduce its capital expenditures while increasing revenues. And this more disciplined growth by the company has resulted in a substantial increase in free cash flow. This free cash flow, however, is unlikely to materialize into a dividend as Green Mountain Coffee Roasters remains steadfast in its mission of having a Keurig® brewer on every counter.
For now, investors in Green Mountain Coffee Roasters will have to be satiated by the company's enviable free cash flow position but should be attentive to any calculated moves by the company that would require cash. For example, on September 17, the company announced that its first Keurig® store is scheduled to open in Burlington, Massachusetts this November. An expansion beyond this first Keurig® store would certainly require more cash. But more importantly it would increase brand recognition and drive consumer adoption, factors crucial to Green Mountain Coffee Roasters' mission. The complete story is yet to unfold but the grass may truly be greener with this single-serve coffee leader.
The Foolish Bottom Line
Dividends are not just for income investors. They can also be helpful in evaluating dividend growth stocks when looked at as a percentage of operating cash flow. The percentage can signify a company's continued plans for growth or the possibility of a slowdown. For Starbucks, I anticipate continued growth in 2014 and expect annual dividend increases for the very long term. But for now, I will raise a Salted Caramel Mocha, Starbucks' lesser-known Fall espresso drink, to future profits, and encourage you to apply this analysis to other dividend growth stocks.
Spencer Naake has no position in any stocks mentioned. The Motley Fool recommends Green Mountain Coffee Roasters and Starbucks. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.