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Starbucks Should Bake Higher Profits With This Acquisition

Alors! Starbucks (Nasdaq: SBUX  ) is plunging deeper into the food business with its just-announced acquisition of French-flavored gourmet bakery chain La Boulange. This is a good move by the coffee king, and if done right it should add at least a few cents to the company's bottom line. It's about time, too, as the coffee maker has never really gotten its act together as far as comestibles are concerned.

Want a bagel with that latte... please?
The great competitive advantage Starbucks has over rivals like Dunkin' Brands' (NYSE: DNKN  ) Dunkin' Donuts and McDonald's (NYSE: MCD  ) is its position as the retailer most strongly identified with premium java drinks. What's an advantage can also be a crutch, though, as most customers visit Starbucks only for a hot drink, neglecting the various food offerings on prominent display in front of them. This contrasts to McDonald's, where coffee is typically just one of the purchases being made.

The coffee purveyor has made a mighty effort to shore up those offerings in recent years, putting healthier options and smaller-sized pastries on the menu. This has boosted food sales, but there's still a long way to go; according to the company, vittles currently account for $1.5 billion of company revenue in its American stores. That's not a huge amount, considering the firm rang up total domestic sales of $8 billion in its most recent fiscal year.

Bon apetit!
This is what makes La Boulange a potentially tasty buy. The company was established in San Francisco by a professional baker, Pascal Rigo, and has grown into a 19-location-strong chain in that city's finicky and competitive market. So Rigo and his bakers are obviously good at making stuff people want to eat.

Which is what the coffee giant needs in terms of food. After all, when was the last time any of us heard a friend or colleague rave about the sandwich wrap or banana bread they ate at Starbucks?

The deal looks very favorable for both parties. Starbucks gets not only La Boulange but Rigo as an executive and presumably something like a Chief Baking Officer (technically he'll be the vice president and general manager of the bakery, which is to become a unit of its acquirer).

On a relative basis Starbucks didn't have to break the bank for the purchase. It came out to $100 million in cash, or approximately $0.13 per share. With $2.2 billion in cash and short term investments Starbucks should easily be able to foot the bill. In its announcement of the buyout, the firm said it expects the buyout to shave $0.02 per share off its earnings in the second half of fiscal 2012. That's barely a bubble in its cappuccino foam.

Investor nourishment
Starbucks is unlikely to be strongly identified with any kind of comestible, unlike its big fast food and doughnut rivals. But the company has the luxury of not needing to. Designer coffee is a high-profit item, which is why the firm's net margins consistently land in the 9%-11% range. This is fat for a beverage/food retail chain. Look at Dunkin' Brands, for example: The margins in its last two fiscal years have come in at 5.5% and 4.6%, respectively.

Still, the coffee slinger can hardly lose by improving its bakery fare and with those better foodstuffs it'll push even further ahead of its nearest publicly traded coffee rivals. Like Starbucks at the moment, Peet's (Nasdaq: PEET  ) and Caribou Coffee (Nasdaq: CBOU  ) are almost 100% identified with coffee.

They're not able to eclipse their huge rival in terms of market presence or sales -- Caribou has 581 stores concentrated in the Midwest and Peet's has fewer than 200 spread across the country; these are tiny footprints compared to that over 17,000 for Starbucks. And with respective cash positions of less than 3% that of their big rival, they'll likely not be buying pastry-making prowess any time soon. So now both will also start to lag behind their massive rival in terms of food offerings.

Starbucks's future growth is probably not going to be powered by food (rather, that'll probably come from international expansion). The La Boulange acquisition should, however, get customers to drop a few more dollars on the tempting treats inside its coffee shops. Since the buyout wasn't insanely expensive, that looks like an efficient way for the coffee king to purchase a little growth.

And that's the caffeine that fuels investors. Find out which company has growth potential so strong that we've pegged it "The Motley Fool's Top Stock for 2012". Download the report for FREE at this link.

Fool contributor Eric Volkman owns no stocks mentioned in the story above. The Motley Fool owns shares of Starbucks. Motley Fool newsletter services have recommended buying shares of Starbucks. Motley Fool newsletter services have recommended writing covered calls on Starbucks. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (4) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 05, 2012, at 12:26 PM, DoctorLewis4 wrote:

    Smart move. The street might not like it but long term this is REALLY smart.

  • Report this Comment On June 05, 2012, at 3:41 PM, TMFVolkman wrote:

    Agreed. Investors usually trade a stock down after a buyout is announced; they don't like the hit to cash flow and EPS. But La Boulange wasn't expensive and has the potential to bring in plenty of revenue.

  • Report this Comment On June 05, 2012, at 3:56 PM, DividendsDiva wrote:

    Smart move for Starbucks, as anyone who has partaken of any of its comestibles. Food quality is generally good but it is overpriced, even for Starbucks but they only make up so much of it for the day and when its gone its gone. It's disappointing to hit the local store at 2 or 3 pm for a caffeine fueling and/or late lunch and find there is nothing left on the food display counter.

  • Report this Comment On June 05, 2012, at 6:37 PM, TMFVolkman wrote:

    It seems to me that they've never had management with significant food experience in charge of their comestibles offerings. If all goes well, that's going to change in the right direction with Rigo in his new position.

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