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2 Key Risks for Starbucks' Ambitious Growth Plan

By Adam Levine-Weinberg - Dec 18, 2016 at 2:35PM

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Starbucks' growth plan for the next five years requires it to succeed well beyond its core U.S. business.

Starbucks (SBUX -1.11%) has had an enormous run of success ever since Howard Schultz returned as CEO almost nine years ago. During that time period, revenue has doubled, operating income has quadrupled, and the stock has produced a total return of more than 600%.

SBUX Revenue (TTM) Chart

Starbucks Revenue, Operating Income, and Stock Price: data by YCharts.

Given this strong track record, investors have good reason to be optimistic about the ambitious growth plan Starbucks unveiled at its biennial investor-day conference earlier this month. Starbucks' future looks bright, even with Schultz planning to retire as CEO next year.

However, the company's growth plan is also risky, in that it's not just calling for more of the same. Starbucks' core U.S. market is starting to get saturated. As a result, the company has had to look further afield for sources of future growth.

Starbucks unveils its five-year plan

For the next five years, Starbucks aims to grow revenue by 10% annually while increasing earnings per share at a 15%-20% compound annual growth rate. This is roughly in line with its growth in the two years since Starbucks' last investor day. To achieve these targets, Starbucks plans to increase its store count by about 50% by 2021, adding 12,000 new locations.

Starbucks plans to open new stores faster than ever in the coming years. Image source: The Motley Fool.

A large chunk of this growth is slated to come from two initiatives I have described as key to Starbucks' future. First, Starbucks plans to ramp up its international expansion, particularly in China. Second, Starbucks is rolling out a new set of higher-end Starbucks Reserve stores, to drive a significant portion of its U.S. growth.

Both international expansion and "premiumization" are promising avenues for growth. That said, Starbucks faces far more risk when expanding abroad (as opposed to domestically). Meanwhile, Starbucks Reserve is essentially an unproven concept.

Leaning heavily on international growth

Of the 12,000 stores Starbucks plans to open in the next five years, fewer than 30% will be in the United States. By contrast, the U.S. accounts for more than half of the company's 25,000-plus stores today.

That means more growth in places like Europe, where Starbucks has often struggled in the past. In fact, Starbucks plans to nearly double its store count in the Europe, Middle East, and Africa (EMEA) region over the next five years. While profitability has improved in EMEA lately, an aggressive expansion of this magnitude may prove to be too much, too soon.

Most of Starbucks' future store growth will be outside the United States. Image source: The Motley Fool.

Starbucks has even more ambitious plans for China, where it plans to more than double its store count to 5,000 by 2021. Indeed, Starbucks has "cracked the code" in China, creating a highly successful business there. But that's not a guarantee of long-term success.

Right now, there's a substantial risk that U.S.-China relations will deteriorate. President-elect Donald Trump has broken decisively from the status quo in terms of dealing with China. This puts every American consumer brand at risk of facing a backlash from Chinese consumers. If anti-American sentiment causes Starbucks to lose a lot of customers in China, the company's growth plans there could quickly disintegrate.

Starbucks Reserve is an unproven concept

After Howard Schultz retires as CEO in April, he will devote his full attention to building up the fledgling Starbucks Reserve brand.

Starbucks hopes to operate 1,000 Starbucks Reserve stores eventually. These locations will be about twice the size of a standard Starbucks store and are expected to bring in twice as much revenue. They will serve only premium coffee, costing as much as $10-$12 for a beverage, along with an upgraded food selection. These new stores will be supported by 20 to 30 Roasteries, which will roast coffee on site in addition to serving coffee and freshly baked food.

In addition to these dedicated Reserve stores, Starbucks intends to add Reserve coffee bars to thousands of regular Starbucks stores. Starbucks is counting on the Reserve brand to drive a meaningful portion of its growth going forward, especially in the United States.

The Starbucks Reserve Roastery in Seattle has become very popular. Image source: Starbucks.

However, Starbucks hasn't fully tested the Reserve concept. Today, higher-end Reserve coffee options are available at some Starbucks locations, but they aren't the main sales drivers in those stores. Meanwhile, the initial Starbucks Reserve Roastery in Seattle has been a huge success, but that's a single novelty store in Starbucks' hometown (and a coffee mecca). There's no evidence yet for how well the Starbucks Reserve concept will travel.

The bold plan to grow at the premium end of the market is based mainly on Schultz's intuition. That's nothing to sneeze at: Schultz's intuition is responsible for much of Starbucks' success.

Still, he's not infallible. Two years ago, Teavana tea bars seemed like Starbucks' next big growth driver. Ultimately, the company closed all but one of its pilot stores, as consumers never really embraced the concept. Starbucks clearly has a lot of growth potential over the next five years -- but there is a meaningful risk that its growth plans won't pan out.

Adam Levine-Weinberg owns shares of Starbucks. The Motley Fool owns shares of and recommends Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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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