Is It Too Late to Buy Starbucks?

Does Starbucks still offer room for growth or is the best part over for the company?

Mar 26, 2014 at 9:08PM


Source: Starbucks.

Starbucks (NASDAQ:SBUX) has been one of the most remarkable success stories in the consumer sector over the past several years, and the company has rewarded shareholders with substantial gains over time. However, market saturation could be a problem sooner or later, and competition is rapidly increasing on multiple fronts, be it from fast food giants such as McDonald's (NYSE:MCD) and Yum! Brands (NYSE:YUM) or traditional coffee players like Dunkin' Brands (NASDAQ:DNKN).

Does Starbucks still offer room for growth, or is the best part over for the company?

Steaming hot competition
Success generally attracts competition, and Starbucks is no exception, as competitive pressure is clearly rising lately.

McDonald's is looking for alternatives to reinvigorate its stagnant sales performance, and the company intends to gain market share in segments like coffee and breakfast. McDonald's is betting on its McCafe concept to expand sales and increase profit margins, while at the same time it's broadening its food offerings in the breakfast segment.

According to CEO Don Thompson: "We're enhancing the breakfast experience by creating more of a coffee culture through high-quality McCafe products. They pair very well with delicious foods, both existing and new."

Yum! Brands' Taco Bell will be launching its breakfast menu nationally on Thursday; the company will offer a waffle taco, a breakfast burrito, premium hot coffee, and Tropicana orange juice among other alternatives in its breakfast menu.

Fast-food companies are facing slowing demand in the U.S. lately, and breakfast seems to be the next battleground in the fast-food war. In addition, Starbucks faces growing competition from traditional coffee players like Dunkin' Brands.

Unlike fast-food chains, Dunkin' Donuts is benefiting from strong demand in the U.S., with comparable store sales rising by 3.4% in the country during 2013. Dunkin' Donuts introduced more than 40 new products during the year, and management is quite optimistic regarding customer response to these innovations and its implications for growth in the middle term.

A differentiated player
No company is completely immune to competition, but Starbucks has been able for a long time to deliver extraordinary financial performance while facing growing competitive pressure, and there is no reason to believe that's going to change anytime soon.

Starbucks benefits from tremendous brand power, a reputation for quality, and a differentiated customer experience. While McDonald's, Yum! Brands, and Dunkin' Brands compete aggressively in the low end of the pricing spectrum, Starbucks is uniquely positioned in the premium segment.

Starbucks reported a big 12% revenue increase during the quarter ended on Dec. 29 to a record $4.2 billion. Global same-store sales increased by 5% during the quarter, and the company opened 417 new stores for a total of 20,184 stores at the end of 2013.

Even in the Americas region, where market penetration is quite high, comparable-store sales increased by 5% on the back of a healthy increase of 4% in transactions and a 1% rise in the average ticket price during the last quarter. New store openings are not cannibalizing sales at existing locations, so Starbucks seems to be far away from reaching a saturation point.

In the China/Asia-Pacific region, where the company has a lot of room for store base expansion, Starbucks delivered a whopping annual increase of 25% in sales during the last quarter of 2013, so international expansion has a long way to go, judging by demand strength.

In addition, broadening the portfolio of products is a smart strategy to generate sales in a cost-efficient way, and the company is firing on all cylinders in that area. Acquisitions like Teavana, Evolution Fresh, and La Boulange provide a deep pipeline for product innovation in the coming years.

The company has recently announced it will start selling beer and wine in thousands of stores, adding more sophisticated food offerings such as bacon-wrapped dates with balsamic glaze and chocolate fondue to its new evening menu in those locations.

Alcoholic drinks are typically high-margin products, and the company's latest menu innovation could provide a lot of leverage by increasing sales during the evenings, a typically a slow time of the day for Starbucks. There could be considerable risks and complications involved in this move, but if it works out as expected, it could do wonders for Starbucks in terms of growth and profitability.

Bottom line
Growth tends to slow down as companies become bigger, and Starbucks is facing rising competitive pressure. However, Starbucks is a high-quality company with a differentiated brand and solid competitive strengths. Demand remains remarkably strong judging by financial figures, and the company has plenty of room for store expansion and product innovation in the coming years. This caffeinated growth story is far from over.

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Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends and owns shares of McDonald's and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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 disclosure policy.

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