Is Starbucks The Brightest Restaurant Stock For The Future?

The year 2016 has been an eventful one for restaurant companies. While Chipotle Mexican Grill (NYSE: CMG) is still recovering from its food virus scandal, McDonald’s (NYSE:MCD) has been aggressively pushing new initiatives to drive sales. Starbucks‘ (NYSE:SBUX) is growing fast, focusing on technology initiatives and expanding its “premium offering.” We look at five restaurant companies in this analysis to see how their revenues and profitability are likely to trend in the next few years.

Both Starbucks and McDonald’s are similar in size when it comes to total revenues.  Given McDonald’s focus on McCafe and Starbucks experimenting with “brunch” offerings, the line of difference in the businesses of these two companies is getting blurred. We expect Starbucks to continue its revenue growth in the next four years. On the other hand McDonald’s might experience a negative CAGR (compounded annual growth rate) between 2017 and 2020.

However, in terms of profitability, McDonald’s enjoys a higher EBITDA (earnings before interest tax depreciation and amortization) margin compared to Starbucks and we expect both companies to retain and grow their margins in the next few years.

These higher margins are primarily due to McDonald’s highly profitable franchisee model  with nearly 90% of its stores being franchised. For company operated stores, Starbucks is expected to earn an EBITDA margin of around 22-23% in the next few years, while the comparative figure for McDonald’s is around 15%.  Dunkin’ Brands enjoys the highest margins in this peer group.  However, its total revenues are around 5% of Starbucks’ revenues. We expect Dunkin’ Brands to post solid growth in revenues  and to maintain its margins over the next four years.

Chipotle’s margins are the lowest in this peer group and we do not expect any significant increase in its margins in the next four years. However, as the company recovers from the e coli virus impact, we expect a significant increase in its EPS over the next few years.

This increase in Chipotle’s EPS is already factored in its market price and our price estimate for the company is marginally higher than its current market price. While Starbucks looks like an expensive stock, given the expected growth in its revenues and stable margins, we are bullish on Starbucks. Our target price for Starbucks is nearly 15% higher than its current market price, based on our revenue and profitability growth estimates for the company.

McDonald’s is working aggressively to grow revenues, experimenting with a number of new strategies (door delivery, table service, mobile ordering and rewards, healthy menu options). However,  we do not expect these to translate into significantly higher revenues over the next four years. Starbucks on the other hand is on a growth path, given its expansion strategy and focus on technology. We believe the restaurant battle will be fought closely by these two companies.  But for now, Starbucks appears to be in the lead.