Why Starbucks Is a Good Bet for the Long Run

Starbucks (NASDAQ: SBUX  ) is the world's leading coffee retailer, with over 11,000 U.S. and 7,000 international locations. The company is back in high-growth mode with global opportunities in its core retail business as well as a new channel development strategy taking place via K-cups. Starbucks continues to justify a high valuation and share price that reflects the scarcity of large growth companies in the stock market universe.

Momentum just getting started in Asia
By the end of 2013, the company expects to surpass 4,000 stores in Asia, including 1,000 stores in China, which will make the country the largest market outside of the U.S by 2014. During the most recent quarter (July), the company announced an increase of 29% in revenue, driven by 523 net new stores, and 9% growth in comparable store sales due to an increased traffic count.

During the company's most recent conference call, John Culver, President, China and Asia Pacific, offered some commentary on the company's global ambition. Mr. Culver noted that the company has been active over the last several quarters and is laying groundwork for sustainable growth moving forward. The company is still investing into the infrastructure, supply chain, and new advertising methods. Mr. Culver is confident that the Asian markets will deliver aggressive revenue growth in 2014 and beyond. 

Even though the company is already experiencing tremendous growth in the region, investors are just seeing a small glimpse of the growth story that is to come. Bloomberg reported that the company is expecting to more than double its Chinese staff to 30,000 by 2015, which indicates the company is still in its infancy stages in terms of development.

Other international markets are performing positively as well with Canada and Latin America delivering significant top-line growth and margin expansion. Management is heavily focused on expanding Asia as evidenced by the company's conference call transcript which revealed the following word counts:

China: 29 matches

Asia: 17 matches

Latin America: 5 matches

Canada: 3 matches

Europe: 3 matches

India: 1 match

Domestic operations are also great
Investors need to be reminded that despite the company's aggressive international expansion, the U.S market is still its largest market. Looking at the company's recent quarterly results shows that U.S operations are positive all across the board.

Same store sales growth of 9% included a 4% contribution from premium beverages and 2% from greater food sales. What is most interesting about the food sales is the fact that this is occurring before the rollout of the premium La Boulange line of food items, which were only available in west coast locations. La Boulange food items should be in 2,500 Starbucks locations including key markets such as New York City, Boston, and Chicago by the end of this fiscal year.

First mover advantage: Mobile payments
Starbucks is the leader and the first restaurant to introduce mobile-based transactions. Through the use of apps on handheld devices, customers are able to load money on a "virtual gift card" and present their phone at any location. A simple barcode is scanned from the handheld device and payment is automatically deducted from the virtual card to complete a transaction quickly and efficiently. Dollars can be loaded onto the virtual card though any major credit card or PayPal.

In terms of specifics, in the recent quarter, dollars loaded onto the virtual card were up 30% year over year.  More than 10% of all transactions in the U.S are done via the virtual card. The company is putting a lot of weight behind this initiative, which is becoming more popular as customers enjoy the convenience of a cash-less transaction. Meanwhile, none of the company's competitors offer such a convenient alternative.

In 2012, CEO Howard Schultz went on to say that Starbucks is "the number one company not in the U.S. but in the world in terms of mobile payment, transactions and dollars."


Source: http://www.geeky-gadgets.com/smartphones-and-starbucks-28-07-2013/

Channel development: K-Cups
As an avid coffee drinker, the largest issue I was facing several years ago is no longer a problem today. I often needed an 'afternoon boost' in the form of a cup of coffee, but I would be too far away from a Starbucks location. Today, I no longer have this issue due to K-Cups. K-Cups are single serving "cups," or pods, that attach to a Keurig machine and brew a single cup of coffee in less than one minute.  These K-cups can be bought at most major grocery stores, retail chains including Wal-Mart and Staples. Keurig is fully owned by Green Mountain Coffee Roasters (NASDAQ: GMCR  ) .

Back in May, Starbucks announced an extension of a long-term strategic partnership with Green Mountain Coffee Roasters that will enable Starbucks to expand its reach and gain additional share in the U.S and abroad. Starbucks currently enjoys an impressive 51% sales growth rate in K-cups, outpacing the overall category growth of 46%.

Naturally, Green Mountain Coffee Roasters also comes out as a big winner as the single-cup coffee category is valued at $8 billion and has grown nine times faster than the overall coffee category during the past year. Sales of K-cups now accounts for nearly 30% of total coffee sales. Green Mountain Coffee Roasters has agreements with many other coffee and tea manufacturers such as Dunkin Brands Group (NASDAQ: DNKN  ) , Lipton, Snapple, and Smuckers.

Competition
A cheaper alternative to investing in Starbucks shares can be Dunkin Brands Group, which has the same ambitious expansion plans to grab market share wherever possible both domestically and internationally. Dunkin Brands Group operates mostly out of the northeast, but has recently unveiled expansion plans to expand out west. The company has also been expanding its menu items and selling K-cups to capture the at-home brewing market. Dunkin Brands Group is franchised, so the company doesn't have to put up capital to open a new store or embody most of the operating costs of running stores, which translates to a much higher operating margin (42.09% compared to Starbucks 16.44% reported in the second quarter of this year).

Finally, Dunkin Brands Group continues to see strong international growth with over 10,000 locations in China alone. While Dunkin Brands Group will likely never catch up to the size and scope of Starbucks, investors will likely see a return on their investment.

In 2013, both Dunkin Brands Group and Starbucks yielded around a 50% return, greatly outperforming the S&P 500. While this trend is likely to continue, I believe Starbucks will offer a superior return over the long run due to its much larger size and reach.

Conclusion
Looking forward to 2014 and beyond, investors can reasonably accept management's revenue growth projections of 10% to 15%, driven by a continued expansion of the global empire both domestically and in key international markets. The company is also projecting 2013 EPS growth of 15%-20%, a number which, at the rate the company is expanding, can be sustained until at least 2015.


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