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Starbucks Corp: A Stock that will Energize Your Portfolio

Starbucks Corp: A Stock that will Energize Your Portfolio
By: Martin Blanc
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Starbucks Corporation (SBUX) stands tall above its competitors as the world’s leading coffee house chain. With close to 19,000 stores spread across 62 countries worldwide, the Seattle-based company employs around 182,000 employees.

The company has set itself apart by providing a distinct, enjoyable coffee-shop experience for its customers. It is best-known for its coffee, but also provides tea and other beverages, along with an assortment of fresh foods. Apart from its namesake brand, Starbucks also owns Teavana, Seattle’s Best Coffee, Tazo, Starbucks VIA, Starbucks Refreshers, and Evolution Fresh.

Starbucks relies on the Americas for most of its operating income. Its business in the EMEA and China/Asia-Pacific regions are still in their growth stages, which signals that most of the company’s future growth will be in these regions – especially in developing economies in Asia.

Starbucks’s rapid expansion into different geographic regions, primarily through new stores, has set it up for sustained growth – and investors should take note. In the first quarter of its 2014 fiscal year (1QFY14; ended December 29, 2013), Starbucks’s net consolidated revenues had jumped 12% over the earlier-year period to $4.2 billion.

Business Model

Starbucks serves customers through both company-operated stores, which represent 52% of its total store count, and licensed stores, which represent the remaining 48%. Company-operated stores account for 79% of Starbucks’s total revenues, but licensed stores are nonetheless important as they provide the only means for the company to reach out to the broader retail market. Starbucks takes extensive care to ensure that licenses are provided only to the most reputable retailers.

It also charges a fee for every license it sells, which accounts for about 9% of the company’s total revenues. In recent years, the company has shown a growing interest in the franchising model, mainly since the wide-scale expansion of company-operated stores in FY07 and FY08 backfired after more stores were opened than were needed. The leaner cost structure offered by the franchising model therefore seems like a neat method to Starbucks to hedge its operating risks.

As can be seen above, aggressive expansion of company-operated stores in FY07 and FY08 led to a sharp decline in Starbucks’s operating margins. In more recent years, the company’s operating margins have steadily improved as it turns toward the franchising model to expand.

A lot of credit for the expansion in Starbucks’s margins goes to Howard Schultz, who was re-instated as CEO of the company in 2008. Schultz, who is also the founder of Starbucks, spearheaded improvements to its business model and accelerated research and development to keep customers coming back for new products. Under Schultz, Starbucks stock, which was trading at $9 in 2008, had spiked to $80 by late 2013.

Starbucks is also focusing on expanding its market share; not only within the regions it currently operates in, but also in emerging markets. It is steadily increasing its store count and looking at ways to boost sales within existing outlets. One way it has tried to spur topline growth is by introducing the Starbucks Card, which allows more convenience to customers, bestows various rewards on frequent visitors, and promotes brand loyalty.

Raw material

The primary raw material for Starbucks is fine-quality Arabica coffee beans, whose prices are subject to volatility in demand and supply. It hedges against supply-side shocks by dealing with multiple suppliers across different countries and using fixed-price and price-to-be-fixed purchase commitments. To ensure consistent supply, the company runs six farmer support centers in six countries that are crucial suppliers.

Market Share

Starbucks competes primarily with quick-service restaurants, specialty coffee shops and other restaurants. Despite intense competition, the company thrives on the superior experience it offers at competitive prices. Starbucks controls around a third of the market in the coffee retail industry, and is the de facto market leader.

Starbucks’s businesses in the China/Asia Pacific (CAP) region have reported the strongest revenue growth rates. The company recently opened its 1,000th store in China last year, and plans to make the country its second-largest market after the US. However, Starbucks’s reliance on China for long-term growth also puts it at risk in case Chinese economic activity slows down.

Comparable Store Sales Growth

The restaurant industry, especially the quick-service segment, has seen a sharp dip in comparable store sales in recent times. While Starbucks has faced some of the same challenges that the rest of the industry has, it has not performed as badly as some competitors. It managed to post 5% growth in same-store sales in its latest quarterly results, and was behind only Dunkin Brands Group Inc (DNKN), which posted comparable sales growth of 6.5%. Krispy Kreme Doughnuts, Inc. (KKD), a close competitor, posted same-store sales growth of only 3.7% in its latest quarter results.

However, Starbucks’s same-store sales growth had slowed in 1QFY14 considering it had been 8% in the previous quarter. Analysts at Goldman Sachs and Barclays had expected 6% growth in same-store sales in the US market, but despite the miss, they agree that it should not impact the company’s long-term growth potential.

Location, location, location: Only 5% of Starbucks outlets are located in malls and other shopping zones, which means the company is barely exposed to changes in foot traffic in these localities. This explains why it managed to post higher sales despite the atypically severe winter this time around.

Catering to the Digital Age

The digitalization of commerce has pressured same-store sales across all companies in the industry, but Starbucks seems well positioned to take advantage of the changing environment.

The coffee house rings up significant volumes of cash from customers who purchase and recharge their Starbucks Cards over the holiday season. The service, first introduced 13 years ago, has seen almost $18 billion in cash loaded onto the cards since then. Thanks to the growing trend of technology-enabled commerce, card activations have almost doubled in the last five years, boosting Starbucks’s cash flows. The card service has been a major success in 28 countries around the world, with the US market accounting for 35% of the tender.

More recently, the company has also partnered up with Apple Inc. (AAPL) to allow customers to pay directly with their iOS-enabled mobile devices, and has also made deals with payment platforms like Square Inc. to provide seamless payments at Starbucks locations.

Increased card activations and revenue growth during FY13 have had a significant impact on Starbucks’s free cash flows. Analysts expect cash flows to rise by another 11% by FY15.

Innovative Menu Additions

Starbucks has moved from being a one-stop shop for coffee and tea to a restaurant that provides a complete dining experience. It now plans to launch a new bakery brand called La Boulange, which will introduce a whole new lunch menu that goes much beyond walk-by snacks. La Boulange is expected to start late 2014/early 2015.

Additionally, a multitude of new flavors have been added in Starbucks’s traditional area of expertise (tea and coffee), and new beverages like handcrafted carbonated cold drinks should create a whole new Starbucks experience for customers. Schultz, the charismatic spearhead of the coffee-making giant, also announced in the annual shareholder meeting held March 20 that the company will be adding to its evening alcohol and light bites menu in many stores across the US.

Another step announced in the meeting was the launch of “Oprah Chai Tea,” the proceeds from which will be used to fund charitable organizations like the Oprah Winfrey Leadership Foundation, Girls Inc., and the US Dream Academy.

Starbucks Corporation (SBUX): Stock Price Performance

New products and an ambient in-store environment have long contributed to respectable same-stores sales growth for Starbucks, and have ensured a steady stream of revenues. Investors have rewarded the company for that, as reflected in the company’s stock price performance.

 

Starbucks stock has returned almost 500% over the last five years. Krispy Kreme, in comparison, has returned more, but also been more volatile. It is currently riding a wave of renewed consumer interest in doughnuts and related snacks, and is therefore valued much higher than Starbucks.

Starbucks’s stock price performance is highly sensitive to its quarterly and annual earnings results. This is largely due to the fact that Starbucks consistently beats earnings forecasts, and even a slight hiccup impacts investors’ sentiments.

Comparables Sheet

Starbucks has posted the highest revenue growth rate among its closest competitors. It also valued at a premium to Tim Hortons Inc. (USA) (THI) and Krispy Kreme, but at a discount to Dunkin Brands. With a market capitalization of over $57 billion, which is about four times its three competitors’ combined market capitalization, and solid fundamentals, Starbucks is a promising stock for any investor.

Conclusion

Even though Starbucks Corporation is playing on a tough field against capable and established opponents, the company has continued to post solid growth and improvements in fundamentals. It is a well-known power brand with a resilient business model, bright expansion policies, creative new products and solid market development ideas. The company is keen on avoiding a high-risk capital structure, and is therefore going for the franchising option to expand. At the same time, it has ensured growth in operating income, which makes it a promising investment. Bidness Etc rates the stock a long-term buy, and recommends you look into what kind of position you can take in it.

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