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Tickers in this Article: SBUX, CBOU, PNRA, MCD
According to the Specialty Coffee Association of America, Americans drink more than 300 million cups of coffee every day. That's right, every single day. So, the assumption is the specialty coffee business must be booming. Ah, but you know what they say about assumptions...

Apparently, only about only 15% of the adult population in the United States partakes in the "specialty coffee experience" (according to the latest Annual Drinking Trends Study by the National Coffee Association). Perhaps Americans just aren't fussy enough, or perhaps the specialty coffee business is just getting warmed up. We're going to look at three of these companies to see if we can get an understanding of the larger picture.

Location Location Location
Starbucks
(Nasdaq:SBUX) with a market capitalization of $20.5 billion and sales of $8.5 billion is the 800 pound gorilla in the specialty coffee business. One of Starbucks' competitive advantages is its first-move ability to snare prime locations - 9,400 of them across the U.S. and another 3,800 in 39 other countries. Starbucks' also plans to open an additional 1,700 this year alone. SBUX picked these prime locations because it knew consumers like convenience so they made it easy to get to a Starbucks store.

Starbucks is one of the most respected coffee names world-wide because of its strong brand, corporate culture and even its social responsibility. The company is quite ambitious; its ultimate strategy is create approximately 40,000 stores (half of which are planned for the U.S.).

Starbucks staffs these outlets with highly motivated people by offering stock options, health insurance, attractive pay packages and plenty of opportunity for advancement. (For more on this, see Go Green With Socially Responsible Investing.)

SBUX success has been closely followed, so the main risk is systemic competition. Perhaps that is why the founder, Howard Schultz, has sold over $60 million of his stock during the past two years. Other than local coffee houses, rivals include direct competitors such as Panera Bread Company, Caribou Coffee, Dunkin' Donuts and even McDonald's (NYSE:MCD). Starbucks counters this threat by offering more than a cup of coffee - but rather "an experience".

Panera Breaks Out The Good China
Order a cup of coffee and a snack at Panera Bread Company (Nasdaq:PNRA) and you not only get it fast, but it will come in a china cup and plate with silverware - not Styrofoam or paper cups. This firm, with a market capitalization of $1.5 billion and sales of $875 million is a mix between fast food and casual dining. The average bill at PNRA is about $8 and the typical store generates an impressive $2 million per year.

Panera currently operates around 1,000 stores across 38 states. Of those, about 40% are company owned and the remaining ones are franchised. The company plans to open stores in Canada this year and has targeted a 17% growth rate over the next three to five years.

Panera's earnings have slowed during the past couple of years to the point where they are now more-or-less flat. The company has a solid balance sheet, but clearly needs to break out of its complacency. Unfortunately, the firm's chairman and CEO, Ron Shaich, has sold over 400,000 shares during the past two years. (For more insight on this, see Can Insiders Help You Make Better Trades?.)


Hamstrung Management

Caribou Coffee Company (Nasdaq:CBOU), while the second largest company-owned coffee-house operator in the United States, is still a far distant second to Starbucks. With a market capitalization of only $137 million, sales of $242 million and 447 stores in 18 states, it doesn't even come close to matching Starbucks. That is truly unfortunate as people often rank Caribou's coffee and pastries as good or better than Starbucks. However, not surprisingly, Starbucks ranks far ahead in convenience. This firm has endured a net loss in each of the last four years, and has only managed a profit in two years since its inception in 1992.

The odds of Caribou taking market share from Starbucks are slim, but it could take on local and regional operations if it chose to. The ultimate build out is speculated in the neighborhood of around 2,000 stores, between company stores and franchises.

Caribou has a good product that should be able to go toe-to-toe with any competitor, but it has two problems:

1. Convenience - Caribou stores are generally not nearly as convenient to get to as a Starbucks.
2. Ownership - The majority stockholder, Arcapita, dictates that the company be run according to the principals of Islam known as Shariah. From a business point of view, these principals may make it difficult for Caribou to obtain financing as it also prohibits the use of certain conventional derivatives to hedge costs or interest rates.

No Accounting for Taste

If you work the ratios between market capitalization and sales of these firms, you will notice some remarkable differences. The performance of these shares has been less than robust over the past two years. Starbucks was the best of the bunch at a 5% appreciation; this must be exasperating for management when the company produces a 28% return on equity (ROE). Panera Bread has declined roughly 20% during the last two years with a 14% ROE. Finally, Caribou has lost about 45% over that same two years with a -12% ROE.

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