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Caribou Coffee (CBOU) is the second largest company-owned premium coffeehouse in the United States, but that isn’t saying much when your primary competition is Starbucks (SBUX). As of January 1, 2012, the company had 581 coffeehouses, including 169 franchised locations, compared to Starbucks’ 17,000+ company-operated and licensed stores. But as the saying goes, a rising tide lifts all boats, and the specialty coffee industry has been on a magnificent growth trajectory in the United States over the last decade. That has been fueled by a consumer trend to go after premium and quality beverages, as well as an appreciation for the in-house experience pioneered by Starbucks in the United States.

Moreover, the two companies have similar offerings. Caribou sells premium coffee and espresso-based beverages, as well as quality teas, cold beverages, baked goods, and breakfast and lunch sandwiches. Caribou also sells its products through various commercial channels and licenses its brand to Keurig, for sale and use in its K-Cup single serve line of business. Despite the obvious similarities, the smaller coffeehouse chain may have opportunities to expand through both retail and commercial venues given its relatively small size. The question is, do consumers want another Starbucks or are they content with the current offering?

Competition in the coffee industry is fierce, with existing players and new entrants looking to differentiate themselves in new and creative ways. It’s no longer about just creating a good, quality beverage. The focus has turned to the experience and ambiance offered inside the store. In this aspect, Caribou Coffee has been able to give customers a satisfying in-store experience by focusing on developing and training its employees. The training that its employees receive is similar to Starbucks in that employees undergo extensive training in customer service and brewing the perfect cup of coffee.  There are some major differences in store design, however. Caribou’s coffeehouses are made to look like log cabins or mountain lodges on the inside, with fireplaces, exposed wooden beams, and oversized furniture.

As far as we can tell, though, the two companies have a lot in common, aside from long-term stock performance. Investors who bought Caribou stock over Starbucks over the last several years would have been largely disappointed. Today the shares trade below their initial public offering price in 2005.  Despite bold expansion plans for the U.S. and international markets, the kind of growth in sales that the company envisioned a few years ago has not materialized. In 2012, the company has delivered respectable same-store-sales growth in the 2%-4% range, and a healthy increase in franchising revenue. However, overall sales are expected to be flat compared to 2011 due to a 40% year-over-year decline in commercial sales to Green Mountain Coffee (GMCR). As a result, recent earnings have been disappointing, with net income in the third quarter falling nearly 6% from a year earlier, to $1.7 million.  

After falling around 20% year-to-date, the company’s shares trade around 20 times the midpoint of management’s 2013 earnings-per-share range of $0.52-$0.55.  Overall sales are expected to grow 6%-8% in 2013. And the company should get a boost in margins next year, as it has locked in lower coffee prices through the third quarter of 2013. Caribou is also introducing new food and beverage products, and expects to see same-store sales growth to continue to be in the 2%-4% range. Still, we view the valuation as lofty, given Caribou Coffee’s current position in the market. With the market as saturated as it is today, future expansion opportunities may be limited. Moreover, many of the so-called good locations may already be occupied by the industry giant. So, in this case investing in the larger, more established company is probably the best way for investors to profit from consumers’ addiction to premium coffee.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.