Can Starbucks Brew Up Another Strong Quarter?

Starbucks (NASDAQ: SBUX  ) releases its fiscal second-quarter earnings report on Thursday, April 24. After coming off the best year in the company's history, the coffee chain delivered another robust quarter to start off 2014; it generated a record $4.2 billion in sales in the first quarter on strong holiday sales and higher store traffic. Can Starbucks continue operating at such a high level? Second-quarter results will help investors find out.

Looking back on Q1
In Starbucks' first fiscal quarter, which ended the last Friday in December, the company opened 417 new stores. This kept it on track to achieve its goal of opening 1,500 locations in 2014 -- a 7.5% increase in total locations.

Starbucks' restlessness in expanding its store base is as much about entering new markets as it is about maintaining revenue growth. There are relatively few remaining opportunities to open new locations within the U.S., Starbucks' largest market, and the company is innovating at a feverish pace just to keep growing U.S. sales. U.S. comparable sales increased 5% in Q1, lower than the 7% growth achieved in Q1 2013.

Digital innovation
Starbucks' second-quarter results will indicate whether its efforts to grow comparable sales are paying off, or if a continued deceleration is in order. The answer may come down to how successful the company is in combating pressures from the Internet. As more transactions are completed through online retailers, fewer people are venturing out to malls where Starbucks is located. Consumers' shift to e-commerce threatens Starbucks' growth rate unless the company finds a way to counter it.

There is reason to believe that Starbucks will be able to protect itself from the rise of e-commerce. Each new conference call contains exciting hints about what Howard Schultz has planned on the digital side of the business. Starbucks is already the leading retailer in mobile payments, with nearly 1 in 6 transactions made with a mobile device. The company's mobile app also tracks loyalty rewards points and allows customers to tip baristas.

Soon, perhaps it could enable customers to pre-order, allowing them to skip the line and pick up their order as soon as they arrive. It might even enable customers to save their orders, making it easy to habitually order one's coffee and breakfast each morning. Look for indications on the conference call as to how Schultz will utilize digital assets in the future and how it brings customers into Starbucks locations.

Expanded menu
Aside from the digital front, Starbucks is also trying to increase U.S. store traffic by expanding its in-store offering. The La Boulange rollout has been well covered on this site, explaining how the new food menu is designed to draw more customers into stores in the later dayparts, when traffic is usually lighter. Last month, CFO Scott Maw told Food Business News that the La Boulange rollout was only 50% complete. However, if comparable sales growth continues to decelerate, investors should question whether La Boulange is achieving its intended purpose.

Look for Starbucks to grow comparable sales by 6% or more -- compared to 7% growth in the same period in 2013. If this comparable is too tough for Starbucks to match, investors should be concerned.

Spiking coffee prices
Aside from comments on digital strategy and information on U.S. comparable sales growth, investors should keep an ear out for discussion of rising coffee prices. A temporary spike in Arabica coffee bean prices has no material effect on Starbucks' profitability. A drought in Brazil -- which accounts for 40% of the world's Arabica production -- caused fears of a supply shortage; the Arabica price spiked to $2.07 per pound, its highest price in more than two years. The price deflated somewhat when Brazil forecast an Arabica surplus.

However, the price spiked once again after a coffee importer's crop-inspection report predicted that more than one-third of Brazil's coffee crop would be lost in the South Minas region due to the weather. If that turns out to be true -- and the Arabica price remains elevated throughout the year -- Starbucks may then be affected.

Nobody knows in which direction the price of coffee will head in the coming months. But investors should discern how much coffee Starbucks is buying this year and what effect the elevated prices will have on its bottom line. If Schultz does not mention coffee prices in his prepared remarks, an analyst is bound to broach the subject. Keep an eye out for his commentary.

Takeaway
Starbucks is going to report another record quarter for revenue; the only question is how much higher it will be than last quarter. Decelerating comparable-sales growth threatens to derail a stock trading at 26 times 2014 consensus earnings. 

The company is implementing digital innovation and rolling out a new food menu to help boost sales growth. If Starbucks falls short of 6% U.S. comparable sales growth, investors should question if its U.S. growth strategy is working. Moreover, the threat of sustained high coffee prices could put a damper on 2015 earnings. Keep an eye out for all of these things when Starbucks reports earnings on Thursday.

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