As Starbucks Cleans House, Investors Will Clean Up

Look out, Europe: Starbucks (Nasdaq: SBUX  ) is back. While the Seattle-based coffee-slinger was preoccupied getting its American house in order, securing China, and making moves in India, the European market suffered. But Starbucks is returning to Europe with a caffeine-fueled vengeance, ready to revamp its operation there and restake its claim as the Continent's premium brew.

Lessons learned the hard way
"In 2008 Starbucks' U.S. business was not in good shape and there are similarities between where that was and where our business is in this region." So said CEO Howard Schultz to his European managers this week as he laid out his plan for retaking the region. Before we get to that, though, some background.

After taking Starbucks from a local Seattle chain to its current state of national ubiquity, Schultz retired as CEO around 2000. Before long there were too many stores, service in the shops had noticeably slipped, and product quality had dropped. Schultz returned as CEO in 2008 and immediately set about whipping the company back into shape. Stores were closed, employee morale was addressed, and the company got back to its roots as a great coffee and food purveyor. A shakeup of similar magnitude, if not by identical means, is in store for Europe.

Michelle Gass, the new boss of Starbucks' Europe, Middle East, and Africa region, will lead the effort. In the U.K., the process is already under way, with Starbucks increasing the number of its stores there from 760 to 1,060. As a special enticement for its U.K customers, the company will also offer free espresso double shots. Additionally, there will be a new ad campaign, and the company will also try to get its beverages on passenger planes and trains across the U.K. For the Greeks, Starbucks will offer a lower-priced cappuccino.

Coffee, tea, and Tata
Getting Europe back on track is key to Starbucks' continued success, especially now that the company has its feet firmly planted in the doors of India and China. In India, Starbucks just inked a deal with Tata, one of India's best-known companies. The joint venture will be a 50-50 proposition called "Tata Starbucks Limited." Its cafes will eventually open in cities across the country, but initially only in Mumbai and Delhi (there sometime in 2012).

Another part of the deal is a sourcing and roasting agreement between the two companies. In it, Starbucks agrees to let Tata Coffee Limited roast coffee for all of the joint venture's new coffee shops. Tata Coffee Limited will also roast beans for general export to Starbucks Coffee Company. The raw beans for both ventures will be sourced from India's state of Karnataka. Getting a foothold in the world's second-largest country and 10th largest economy, in a joint venture with one of India's best-known companies, is an epic deal for Starbucks.

China is coming along nicely, as well. It has industry-topping margins and is set to grow by leaps and bounds. "We will open thousands of stores in China over the next few years," Schultz said of the China effort.

The competition is not what you think
Starbucks' traditional competitors in America aren't the main issue in Europe. Dunkin' Brands (Nasdaq: DNKN  ) has a presence in Germany, Spain, and Russia, but ultimately lacks the same scale in Europe. Green Mountain Coffee Roasters (Nasdaq: GMCR  ) is still only a domestic rival. McDonald's (NYSE: MCD  ) can certainly be found throughout Europe, and it has upped its coffee game in recent years. But Starbucks' biggest competition on the Continent is austerity.

Much of Europe is in recession, and countries from Spain to the U.K. to Greece are in the throes of austerity programs designed to cut government debt by cutting government spending. But when you cut spending, you curtail growth, making Europe's already fragile economy only more so, hence the cheaper cappuccinos for the Greeks and the free double shots for Brits.

Schultz at the helm
Aggressive expansion? Wasn't that what got Starbucks into trouble in the U.S.? Yes and no. I think it's more accurate to say that a poorly executed expansion was what caused the trouble. Howard Schultz is an outstanding CEO, and Starbucks is his baby. That's why he came back. He couldn't stand to see it struggling. The last time Starbucks tried this, Schultz wasn't at the helm.

And now, management has a tried-and-true reboot story to follow: the astonishing turnaround of Starbucks' U.S. market. Also, the company cannot wait until Europe is out of recession to get re-established there; that could take years. The time is now, and the leadership is right. For investors, the stock price, at $48, is very reasonable, if the P/E, at 29, is high. But you're getting a lot of company for the multiple. With this move back into Europe, I believe Starbucks is doing what it needs to do to stay growing and profitable.

Just don't expect an instant turnaround. It took time with the U.S., and it will take time with Europe. Schultz is taking the long view, which we here at The Motley Fool love. Here's something else we love at The Motley Fool: a stock we're calling our top pick for 2012. Read all about it in our special free report, aptly titled "The Motley Fool's Top Stock for 2012." Get it while the stock is still hot by clicking here now.

Fool contributor John Grgurich thinks a "business" trip to London or Paris is in order to see just how Starbucks' revamp is coming along, but he owns no stock in any of the companies mentioned in this column. Follow John's dispatches from the bloody front lines of capitalism on Twitter@TMFGrgurich. The Motley Fool owns shares of Starbucks. Motley Fool newsletter services have recommended buying shares of Starbucks, Green Mountain Coffee Roasters, and McDonald's. Motley Fool newsletter services have recommended creating a lurking gator position in Green Mountain Coffee Roasters. Motley Fool newsletter services have recommended writing covered calls on Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a perfectly scintillating disclosure policy.


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