coffee-cup-beans

For more than a decade, we’ve been using a process that’s centered on selecting investments based on qualitative markers, as opposed to traditional quantitative markers (see “An uncommon approach to stock selection,” for more detail about our process).

Our theory uses three main pillars:

  • Is the company a dominant player?
  • Is the company in a growth industry?
  • Does the company produce a good or service that consumers will pay more for?

If one of these criteria isn’t met, we don’t buy. Let’s put the theory to the test. We’ll analyze three companies within the same industry.  This month, we’ve chosen the coffee industry—so rise, shine and let’s start with java.

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Tim Hortons (THI): Tim’s is an iconic Canadian brand. The company fits some of our criteria, but not all. It’s a dominant company in its space with over 3,600 locations in Canada and the U.S.

It also does very well with the notion of pricing power. If Tim’s decided today that a decaf double-double would now cost $1.85, as opposed to $1.60, I would pay up. That’s because the company is still selling its product at a reasonable price compared to its competitors. For Tim’s, if you take this 25-cent increase and divide by the base revenue of $1.60, it translates to a whopping 16% increase to their top line numbers.

So where’s our problem with Tim’s then? Growth. Sure, it’s rolled out some 600 stores in the U.S.—mostly in the northern states where there is more Canadian influence. But the results of the U.S. expansion have been lukewarm. And McDonald’s, Dunkin’ Donuts and Starbucks have all pushed back hard with revamped offerings.

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We’re also concerned about who it is Tim’s appeals most to. Walk into a Tim’s anytime during the day and note the number of older folks loitering at about $1.60 an hour, which won’t pay the rent. Compare that to the typical Starbucks customer who is about 20 to 30 years younger and willingly pays more for a cup of coffee and biscotti. They are spenders, and that’s key for any retailer.

Since Tim Hortons doesn’t pass all three of our criteria, we don’t own any of its stock. Still, it’s trading at about $ 80, after a recent surge due to the Burger King deal. It’s up 174% in the last five years. That’s good, but we aren’t sold on the marriage between Burger King and Tim Hortons, yet, especially considering that Tim’s has already danced unsuccessfully in the past with both Wendy’s and Cold Stone Creamery. Neither of those partnerships lasted, so we’re not yet convinced the third time’s a charm. They haven’t exactly hitched their wagon to a growth story and frankly, there are more profitable options.

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Starbucks (SBUX): The company is dominant and in a growth industry. And, consumers will pay more for the product, which can cost at least twice as much as Tim’s. Why would they do that? Because they believe it’s better coffee, and while we won’t debate that assertion, we will use it to grade Starbucks’ stock highly.

Also, Starbucks has found a way to appeal to even more customers. It owns Seattle’s Best, which is a mid-tier coffee brand. So those who are budget-conscious can also enjoy the Starbucks feel without paying the Starbucks price.

The company meets all our criteria, so it gets the green light. We bought Starbucks shares on Feb. 23, 2004 for US$ 18.85. The shares currently trade at $74.59, up about 305% in the last five years. (The purchase price reflects the 2:1 stock split that occurred.)

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Keurig Green Mountain (KGMC): With over 100 brands, Keurig dominates the pod coffee world, which is growing faster than the retail cup. Keurig has also teamed up with Starbucks, Dunkin’ Donuts and Tim Hortons to market branded pods for the Keurig brewing system.

If that weren’t enough, the company is taking direct aim at SodaStream, with the unveiling of a carbonated drink machine. For those who think this is a fad, think again. SodaStream has sold millions of machines around the world.

But here’s the kicker.  Many investors may not know that Coca-Cola recently bought 16% of Keurig Green Mountain, and the two companies will jointly develop Coke pods for the Keurig machine. The folks over at Coke are banking on the fact that soft drink sales in the developed world are shrinking, while coffee sales are not.

We bought into Keurig in August 2014. It trades at US$130.55, up about 600% in the last five years.

*All stock prices are current at time of publication.

The opinions expressed are those of the author and may not necessarily reflect those of Manulife Securities Incorporated. Manulife Securities Incorporated is a member of the Canadian Investor Protection Fund.

Steve Barban and Russell Hope have been providing Gentry Capital Un-Common Sense© to their clients for many years. They are financial advisors with Gentry Capital/Manulife Securities Incorporated.
Originally published on Advisor.ca

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