Starbucks (SBUX 0.47%) had a stellar year in 2013; it posted a record $14.9 billion in revenue and grew earnings per share by 26%. But what matters for investors is what lies ahead -- and for Starbucks, 2014 could be an even better year. Three trends will boost Starbucks' results to the detriment of Dunkin' Brands (DNKN) and McDonald's (MCD -0.91%).
Falling coffee prices
Although prices will rise in the long run due to growing demand relative to supply, the price of coffee is getting cheaper in the short run -- falling from $2.82 per pound in April 2011 to $1.14 per pound in September 2013. The low price will boost Starbucks' near-term earnings performance.
Although Starbucks has substantial pricing power, competition from Dunkin' Donuts and McDonald's in a weak consumer environment keeps it from raising prices too high. As coffee prices rose in 2011, Starbucks was hesitant to rely on price increases to offset higher input costs; instead, it focused on driving more traffic to stores through its loyalty program and on increased efficiency. The consumer packaged goods segment -- which includes Starbucks packaged coffee sold through grocery channels -- suffers the most under high prices (and benefits the most from low prices) because the coffee cost is a larger component of the cost structure than it is for the retail stores. Consumer packaged goods represents only 12% of overall sales. Even so, the combined cost pressure in retail locations and packaged goods caused a 10.7% hit to 2012 operating income, with a much greater impact on the first half of 2012 as Starbucks was still paying elevated prices for its coffee.
That is not to say that Dunkin' Donuts or McDonald's fare any better under high prices. In fact, their value proposition is even more difficult to maintain than Starbucks' when commodity prices rise. However, Starbucks' earnings still take a beating from high input costs -- and receive a windfall when costs are low.
Burgeoning Asian middle class
McDonald's and Dunkin' Brands have already had success expanding in Asian countries, but Starbucks is still in the early stages of international growth. The company plans to open 750 Asian locations during 2014 -- the bulk of which will add to its 1,000 Chinese Starbucks locations.
Starbucks' bet on China is a good one if it can achieve the success that McDonald's and Dunkin' Brands have had in the country. Dunkin' Brands has rapidly expanded in Asia and the Middle East via franchise agreements; the region now accounts for 23% of Dunkin' Brands' global franchisee-reported sales.
McDonald's is also expanding in China; at the start of the year, the company planned to add 275 new stores to its China base, bringing the total to 2,000 by the end of 2013. That both companies are still expanding in China despite a slowdown in the economy indicates the long-term success they expect in the country.
Starbucks' China locations are already showing promise. Locations opened during 2012 already gross $700,000 per location, more than half that of the company's mature locations in the Americas. If the Chinese locations turn out to be anywhere near as profitable as the Americas locations, then Starbucks has an enormous opportunity in serving China's growing middle class.
Mobile apps and loyalty programs
The proliferation of mobile applications is a huge benefit to Starbucks, which relies on mobile apps for payment and its loyalty program. The company was an early investor in Square, a company that allows customers to pay for orders using their mobile phones. This makes it easier for customers to pay for their order.
Starbucks' loyalty program is another important part of drawing more customers into the stores more often. Loyalty program members earn Stars by using their Starbucks card, mobile app, or Star codes found in packaged coffee sold in grocery stores.
The program has three reward levels: Welcome, Green, and Gold. Welcome is the default status that is attained upon signing up for the loyalty program; it enables users to receive a free drink on their birthday. Customers reach the Green level when they earn five Stars; it enables them to get free refills in addition to a free drink on their birthday. Gold status customers -- those who earn 30 Stars within a 12-month period -- get all those perks plus a personalized Gold card, a free drink for every 12 Stars, and special discounts available only to Gold members.
In a country plagued by status-seekers, Starbucks' color-coded cards could soon acquire similar meaning as American Express credit cards. This would persuade loyal customers to buy even more Starbucks coffee -- a welcome event for shareholders.
Bottom line
Starbucks is a great business that has a proven ability to grow in any environment. However, even the best of companies can benefit significantly from tailwinds. Starbucks is poised to benefit from low coffee prices, a growing Chinese middle class, and the traffic increases driven by its loyalty card program. As a result, shareholders can expect another stellar year in 2014.
