Starbucks' Future: Short, Tall, or Venti?

Starbucks (Nasdaq: SBUX  ) recently reported a 37% increase in third-quarter earnings. Customer visits are up and same-store sales are up around 9%, but the company issued a lower-than-expected profit forecast for its next fiscal year. So what does the future hold for the coffee giant? I recently asked Motley Fool Million Dollar Portfolio Associate Advisor Charly Travers.

Mac Greer: Charly, is the skim mocha decaf latte half-full or half-empty?

Charly Travers: Half-something about sums it up. The one thing I really like that Starbucks has done this year is they have finally gotten around to instituting a dividend. It started out about a dime per quarter and it didn't take them long to bump that up to 13 cents a share. So right now the stock is giving you a 2% yield. I would like to see the growth company make the transition to a dividend payer, and I am sure that makes a lot of income investors happy.

On the flip side, not too long after they shut down several hundred stores, which was kind of a high-profile failure on their part in their expansion, they are right back at it again. I think they said they are going to launch something like 500 stores this year, which is just crazy after what they went through.

Mac Greer: A couple years ago, Howard Schultz was talking about Starbucks losing its soul and yet, as you just mentioned, they are embarking on this growth plan again. Schultz is given a lot of credit for building Starbucks into this megabrand. What do you think of Howard Schultz's leadership?

Travers: Is there a Starbucks soul? I mean, let's be honest here. I am not sure Howard Schultz has ever been in an independent coffee shop. … Starbucks is not an experience; it's an assembly line to get your coffee. They talk about having a place where people can sit down and hang out, that is completely bogus.

I would recommend people read a book called The Halo Effect by Philip Rosenzweig. Howard Schultz did do a great job building this company. It is a phenomenal brand and a true success story. But to say he was the savior when he came back is a misattribution because the problem Starbucks ran into came under Schultz's watch in the first place. Yes, he stepped down as CEO in 2000, but he was the chairman of the board the whole time and even had the title of chief global strategist. So if overzealous growth was the problem, it did come under his watch. And so when he came back in 2008, it was like "Howard Schultz is going to save the company." Well, where had he been the last eight years? I thought he was on the board helping to oversee the company.

Greer: So what do you make of this expansion then? Did they not learn their lesson the first time or are they doing it smarter this time?

Travers: There is one key difference. The first time they had to fork out their own cash, and these are company-owned stores, a lot of them. This time, these are almost going to be all licensed stores, which if you follow the restaurant business, you can think of as franchises. The difference there is Starbucks isn't putting up any of the money upfront. They are just collecting a royalty stream and payments out of the people who are operating the store. This has actually been the continuation of a trend for Starbucks. Five years ago, it was only a little over a third of their stores were licensed and it is approaching 50% now, which is getting them closer to some of the big dogs in the industry like Yum! Brands (NYSE: YUM  ) and McDonald's (NYSE: MCD  ) , which are probably two-thirds to three-quarters franchised. So this is the way they can do it smart. But that said, it is still a little concerning about cannibalizing sales of nearby stores.

Greer: And you mentioned Yum! Brands and McDonald's. Who do you see as the greatest competitive threat to Starbucks?

Travers: I think it hasn't changed over the last couple of years. I think it is McDonald's and Dunkin' Donuts.

Greer: So what do you see as Starbucks' biggest untapped opportunity?

Travers: I think when most people think of Starbucks, they think of the coffee stores. I think the bigger story here is the consumer goods. If you go in the store, you see the Starbucks ice cream and the Frappuccino drinks. These are very profitable. I almost see the stores as a brand-building consumer awareness kind of part of the company pushing more product through the grocery stores through some partnerships with companies like Kraft (NYSE: KFT  ) .

Greer: And Starbucks recently increased its dividend, which it first introduced back in March. Do you think Starbucks is a good investment for investors looking for income?

Travers: A 2% yield probably doesn't excite too many income-oriented investors, but at the same time, the company really could become more appealing over time. This is a really strong consumer brand with great cash flows and more importantly, it has the ability to steadily increase this dividend over time, which if an income investor doesn't like the yield, they would like the dividend increases they could expect probably over the next five to 10 years. If you look at strong consumer brands like Nike (NYSE: NKE  ) , Pepsi (NYSE: PEP  ) , Coca-Cola (NYSE: KO  ) , these are the darlings of income investors and maybe one day you will lump Starbucks in that category, too.

Neither Mac Greer nor Charly Travers owns any of the stocks discussed. Coca-Cola is a Motley Fool Inside Value choice. Coca-Cola and PepsiCo are Income Investor recommendations. Starbucks is a Stock Advisor recommendation. Motley Fool Options has recommended a position on PepsiCo and a bull call spread position on Yum! Brands. The Fool owns shares of Coca-Cola. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


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