Coffee has certainly become a hot commodity over the last decade or so, and in more ways than one. Companies are producing higher quality coffee, which produces "fancier" drinks, which allows those companies to charge higher prices. The shares of these companies have also become a little expensive, which tells me that the market's answer to "how much premium coffee can Americans consume" is simply "more".
The premium coffee business has evolved significantly in two main areas. In broad terms, the way consumers make their own coffee at home has changed, and the way we go out for a cup of coffee has changed.
Coffee at home
The most significant change to the way we make coffee at home is the emergence of the single-serve brewer. There is none more well-known than the Keurig brewers by Green Mountain Coffee Roasters Inc. (UNKNOWN:GMCR.DL). Just when it looked like the company's growth had ended, Green Mountain proved the market wrong with a string of good quarters.
As a result, its shares have risen dramatically from the lows. Even after the recent pullback, Green Mountain's shares are about 160% more expensive than they were a year ago. With single-serve brewers continuing to exhibit impressive growth, expectations are still lofty for the company. The single-serve coffee market grew from about a $1 billion market in 2011 to a $1.8 billion market in 2012. It is estimated that single-serve coffee makes up just 30% of the market which leaves plenty of room to grow.
Green Mountain is expected to report earnings of $3.26 per share for the current fiscal year that ended September 29, 2013. This is projected to grow to $3.80 and $4.47, for annual earnings growth of 16.6% and 17.6%, in 2014 and 2015, respectively.. So, the fact that Green Mountain trades for 19 times its most recent years' fiscal earnings doesn't seem too bad. While shares of Green Mountain are no longer the amazing bargain they were last year, they are still attractively valued at their current price.
Coffee on the go
Starbucks Corp. (NASDAQ:SBUX) has completely transformed the way the world looks at going out for coffee. The particular genius of Starbucks is that it figured out how to produce a product and atmosphere that is simply so much better than the competition that people are completely fine with paying $5 for a cup of coffee. With an aggressive growth strategy and continuously evolving product lines, Starbucks is now one of the largest quick-service chains in the world.
The problem with Starbucks as an investment is that shares may be pricing in a little too much growth. Shares trade for almost 36 times what the company is expected to earn in FY 2013. The 19% forward growth rate projected for the company doesn't quite justify the lofty price. At some point, the company's growth momentum will slow. When that happens, shares could fall back down to earth quickly.
Despite the fact that it is an expensive investment, Starbucks has definitely changed the culture of the coffee business. McDonald's Corp. (NYSE:MCD) has started to offer an extensive line of gourmet coffee drinks, realizing that "run-of-the-mill" coffee is no longer good enough for consumers. The company operates its subsidiary McCafe, which is a coffee-house style chain with about 1300 locations worldwide. It is the leading coffee shop brand in a few countries. Although the stand-alone coffee shops are a relatively small part of McDonald's, the McCafe coffee drinks are available at the company's traditional restaurants.
McDonald's may actually be the best value of the companies mentioned because it is currently experiencing a nice wave of growth (some of which can be attributed to its coffee success). McDonald's is also an excellent dividend payer (about 3.2% vs. Starbucks' 1.06%). At just 16.9 times 2013's estimated earnings, McDonald's looks pretty cheap considering its projected 10% annual earnings growth over the next few years. For income seeking investors it is worth noting that McDonald's has increased its dividend payout every year in recent history, including throughout the latest recession.
While the king of coffee, Starbucks, seems to be a bit too expensive there are some viable investment choices in the sector. Green Mountain looks especially tempting right now, as shares have pulled back by about 30% from the highs of this summer and all signs point to continued growth for the single-serve coffee industry.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Green Mountain Coffee Roasters, McDonald's, and Starbucks. The Motley Fool owns shares of McDonald's and 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.