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Scalding-Hot Coffee Wars

The coffee wars scorch on. Retail wunderkind Starbucks Corp. has come up with a few new tricks in recent months in its attempts to widen the lead it has built over other java sellers at a time when Dunkin' Donuts has its sights set on becoming a national player and upscale upstarts try to erode the chain's market share.

In the past decade, consumers and real estate developers alike flocked to the Seattle-based chain, making it the leader in the U.S. specialty coffee market and a preferred anchor tenant for shopping centers with less than 15,000 square feet of space. As a result, the company today operates 9,814 U.S. stores (6,281 are company-owned, 3,533 are run through licensing agreements) and become an international phenomenon.

But lower-than-expected sales growth during the company's fiscal third quarter may be one indication that Starbucks' momentum is slowing. During that period, the company reported same-store sales growth of 4 percent and a 20 percent increase in net revenue to $2.4 billion. That was good — but the growth missed analysts' expectations of 6 percent growth, reflecting flat traffic for the second consecutive quarter, according to Marc Greenberg, retail analyst with Deutsche Bank. Greenberg worries the waning traffic and increased pressure from competitors will hurt Starbucks' aggressive expansion plans.

Owners and operators of smaller strip centers that rely on Starbucks as an anchor are watching closely. Such centers trade at cap rates in the 5.00 percent to 6.00 percent range, below the national average of 6.65 percent for all strip centers, according to Anthony Villasenor, principal of retail investment with La Jolla, Calif.-based Lee & Associates. Meanwhile, a center of equivalent size and profile anchored by a Dunkin' Donuts or another coffee chain would trade at up to 35 basis points higher, says Chad Firsel, executive vice president of the investment services practice with Chicago-based brokerage NAI Hiffman.

Still, Canton, Mass.-based Dunkin' Donuts has emerged as an unlikely challenger to Starbucks. Beverages now account for between 60 percent and 70 percent of the company's annual revenues. In its fiscal year 2006 ending August 2006 — the last year for which information is available — Dunkin' Donuts posted sales revenues of $4.6 billion overall. In contrast, Starbuck's global retail revenue was $6.6 billion.

In August, Dunkin' signed the largest store development agreement in its history and will open 105 new sites throughout Allegheny County, Pa. Overall, the chain plans to triple its domestic store base from 5,300 to 15,000 by 2020.

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