Will Starbucks' Howard Schultz Shake up Retail Again This Week?

In its last quarterly report, coffee giant Starbucks (NASDAQ: SBUX  ) made headlines as much for its comments about retail as it did for its strong performance. CEO Howard Schultz is becoming well known for his commentary on everything from politics to consumer spending. So while Starbucks investors are eager to hear if Starbucks is still keeping fast growing competitors Dunkin' Brands (NASDAQ: DNKN  ) and Krispy Kreme Doughnuts (NYSE: KKD  ) at bay, investors of all stripes will be tuning in to hear Schultz comments on retail.

Starbucks second quarter earnings are on tap this Thursday April 24, 2014. Here are three keys to watch.

Source: Sillygwailo via Wikimedia Commons

Will Howard Schultz shake up retail again?
In its most recent quarter, Starbucks CEO Howard Schultz made big headlines by declaring that traditional retail was in decline. Schultz said the fourth quarter of last year saw the first "fundamental" shift of consumers moving away from shopping malls, and brick-and-mortar locations, to online. What followed appeared to back up Schultz comments, as traditional store traffic fell 14.6% during Thanksgiving and Christmas in 2013, while e-commerce grew. 

The question is whether those figures were due to poor weather conditions, or a greater fundamental shift. You can bet that plenty of investors will be listening in to Schultz comments this quarter, to get a better handle on where retail (as a whole) is headed. I however, will be eager to see how Starbucks is continuing to adapt to this changing environment. 

Motley Fool One Analyst Jason Moser recently said that Starbucks was weathering this trend well by becoming "more things to more people." Rather than relying solely on shoppers to visit stores for coffee, Starbucks has other avenues for revenue growth from Teavana, La Boulange, and even online shopping (they deliver the coffee to you). This is all true, but these are still transitions from the typical Starbucks model, and any hiccup could mean some pain for investors.

The biggest weapon Starbucks has in this fight is its rewards and loyalty program. These programs work for both Starbucks and customers; Starbucks gets its payment up-front, customers are therefore drawn into a store, and customers get freebies for shopping. During last quarter Starbucks programs saw $1.3 billion in transactions, one big key to watch this quarter is for that number to grow. 

Is Starbucks beating the law of large numbers?
During its most recent quarter Starbucks guided to a whopping 1,500 new store openings in 2014, with 750 coming from China and Asia Pacific. Starbucks currently has roughly 10,000 company owned stores, and 9,500 licensed locations. Compare that to Krispy Kreme (800 stores) and Dunkin' Donuts (11,000 locations, not including Baskin-Robbins), and it seems unfathomable that Starbucks will actually open so many new stores. In this year alone, they plan to open more stores than Krispy Kreme has--period. 

Image of a Starbucks in South Korea. Source: Kenneth Han via Wikimedia Commons

At some point investors have to ask, when will the law of large numbers will impact Starbucks? One number to watch is same-store sales; perhaps the most important metric for any restaurant in "growth mode." As new locations open, customers have a shorter distance from their home to a Starbucks, which can thin out revenues at each store unless the demand truly robust. So far, Starbucks has driven same-store sales higher nicely (on higher traffic), with last quarter's comps growing 5%. For this quarter we'll want to hear positive guidance on new stores openings, sames-store sales, and sales at stores open less than one year. 

Rising coffee prices could put pressure on profit margins
I'm blown away by how similar Starbucks and Dunkin' Brands are, from an investment standpoint. Krispy Kreme is different. If you're investing in Krispy Kreme, you're doing so because they have a smaller store count with more "white space" for expansion, but the stores are less popular (just 1.6% comparable sales growth last quarter). But Starbucks and Dunkin'? They couldn't be more similar. 

Starbucks first quarter earnings that saw a 25% jump in earnings, sales were up 12%, and comparable sales were up 5%.Dunkin' Brands earnings jumped 26.5%, revenues were up 13.3%, and comparable sales rose 3.5%.

Both stocks even trade at similar valuations, with forward P/E's of 26. So what can separate these stocks from each other? The one area were Starbucks lags Dunkin' is in profit margins, in part because of its reliance on drink sales. 

DNKN Gross Profit Margin (Quarterly) Chart

DNKN Gross Profit Margin (Quarterly) data by YCharts

Those profit margin woes could be challenging going forward because, as the chart below shows, coffee prices are soaring. 

Coffee Arabica Price Chart

Coffee Arabica Price data by YCharts

La Boulange is a big key to Starbucks margins because the larger profit margins of food sales help shield the blow of high coffee prices. Be sure and listen to the company's release closely for other plans that management has to weather higher coffee prices. 

Howard Schultz has a tall order
Expectations are high for Starbucks and, with so many new ventures also under way, the possibility for a misfire is higher than usual. Yet, I feel that this management team that is constantly ahead of retail trends, will likely be up to this tall order in the long-run. 

To summarize, Foolish investors should focus on same-store sales, new store expansion, and Starbucks rewards program. Those keys will tell you if Starbucks is ready to handle the new trends in retail.

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