Why You Should Buy Starbucks After a Solid Second Quarter

Starbucks' (NASDAQ: SBUX  ) second-quarter earnings report and conference call reinforced its position as the preeminent quick-serve restaurant chain. Although revenue came in lower than expected, earnings were slightly better than expectations and showed a healthy 10% increase versus the same quarter a year ago. Comparable-store sales were also impressive, and CEO Howard Schultz hinted at an exciting new way to monetize Starbucks' mobile application.

Finally, CFO Scott Maw told investors about the one commodity price that is even more important than the coffee price. In all, Starbucks delivered a strong quarter and gave investors plenty to think about for the future.

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Robust comparables
Starbucks' first-quarter U.S. comparable-store sales grew a disappointing 5%, 2 percentage points lower than the same quarter in 2013. In the second quarter, comparable-store sales grew 6% in the U.S. and globally. That matches 2013's second-quarter global growth and is just 1 percentage point below year-ago U.S. growth. This is impressive given the disruptions caused by severe winter weather during the quarter in the U.S., which led to "unprecedented store closures," according to Maw.

Starbucks is driving comparable-sales growth in its U.S. stores -- which account for 58% of its total store base -- by expanding its menu to encourage higher traffic later in the day and higher ticket prices in the morning. The company is finishing the rollout of La Boulange bakery items and is now focused on bolstering its lunch menu. COO Troy Alstead said Starbucks will test lunch items beyond its current offering of bistro boxes, paninis, and salads. It will also push craft soda and Teavana tea as part of its lunch offering. If Starbucks can come to be seen as a lunch destination, in addition to a morning coffee shop, comparable-store sales will continue a steady march higher.

Digital innovation
In addition to creating menu innovations, Starbucks is innovating on the digital front. Already, 10 million Starbucks customers have downloaded and actively use its mobile application, which used to conduct 14% of transactions in company-operated U.S. and Canadian stores.

The application is so robust that Starbucks has been asked by tech companies and national retailers to license its mobile technology. Schultz says the interest proves that Starbucks is way ahead of the pack, telling investors on the conference call:

We have such a significant lead. There isn't a company that we can identify that is processing anything close to a million transactions per week, and we're now way over 5 million. Most of the national retailers did not invest ahead of the growth curve. They do not have the capability in-house at this point to execute this and to fully understand it.

Starbucks' mobile application integrates its loyalty card and a mobile wallet, allowing customers to earn rewards and pay with their mobile phones. In the future, it could do much more. With so many customers using the mobile app -- and with interest pouring in from other retailers -- Starbucks is clearly the leader in mobile retail.

Commodity prices
Coffee prices are elevated due to feared shortages in Brazil -- the world's largest coffee producer. Severe weather -- including drought and torrential rain -- caused Arabica prices to hit a 26-month high, and analysts predict prices could increase another 18% by year-end.. High coffee prices will hurt Starbucks only if they remain elevated for an extended period of time.

On the second-quarter conference call, Maw assured investors that Starbucks' coffee needs are locked in for 2014 and that more than 40% of 2015's needs are already purchased through futures contracts. Starbucks will feel the impact of the recent price surge only if prices remain elevated for several months into fiscal 2015.

Source: Starbucks

Maw said he is more concerned about dairy prices than coffee prices. The dairy market is not as deep as the Arabica market; Starbucks can only hedge three- to six-months' worth of dairy purchases. Strong demand and increased exports have caused dairy prices to increase across the board. At $22.55 to $23.05 per cwt, the average milk price is at an all-time high. Maw said that, although this creates a headwind, overall commodity costs will actually come out lower than in 2013.

Foolish takeaway
Starbucks delivered a strong second quarter. Its global comparable sales growth matched the year-ago quarter's growth, and its U.S. comparable sales were solid despite severe weather. The company also hinted at possible monetization of its mobile technology via licensing arrangements. Even if these arrangements are never finalized, other retailers' interest is a sure sign of Starbucks' leadership in the arena.

Finally, commodity prices are elevated, but Starbucks will only be affected if they remain elevated throughout the year. Overall, Starbucks turned in another solid quarter that should keep investors optimistic about its future.

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