This article is part of our Rising Star portfolio series.
Not too long ago I opened a position in Starbucks (Nasdaq: SBUX) for my Rising Star portfolio. The idea was (and is) pretty simple: Starbucks has a brand recognized the world over, and there are plenty of growth opportunities still ahead.
Still, I think some of their biggest challenges lie in growing market share in places like China and India as well as growing their consumer-packaged-goods segment to one day rival that of their retail store segment.
I always find it helpful to take a look at companies through Porter's Five Forces to get a better grip on their competitive advantage and potential areas of weakness; threat levels can range from high to low and everywhere in between. While the model is far from perfect, taking a look at barriers to entry, threat of substitutes, power of buyers, power of suppliers, and industry jockeying can bring up new questions that I may not have thought about otherwise.
Barriers to entry -- medium/high
Coffee isn't exactly rocket science (though I'm sure the folks who developed VIA would beg to differ). It's a craft for sure, and it's no small feat to run a global operation either. But back to its roots, Starbucks was a one-store operation in 1971 and by the time Howard Schultz bought the company in 1987 there were 17 stores. The point is that even with close to 17,000 stores worldwide today, the company had to start somewhere. There's nothing stopping someone else from giving it a whirl.
Threat of substitutes -- high
Coffee is tough business! And while coffee drinkers tend to be a loyal bunch, there are all sorts of temptations out there. McDonald's (NYSE: MCD), Peet's (Nasdaq: PEET) Green Mountain Coffee Roasters (Nasdaq: GMCR), and Caribou Coffee (Nasdaq: CBOU) are just a few of the alternatives out there fighting for the coffee bucks. There's even talk of a possible Dunkin' Donuts IPO later this year, which could certainly give it the opportunity to spread its doughnut-encrusted caffeinated wings as well. And don't forget that Starbucks substitutes aren't limited to just coffee.
Power of buyers -- high
In the grandest sense, consumers are the buyers here. We are the ones buying the coffee from Starbucks' retail stores, and we are the ones buying it from the shelves at the grocery store. They get shelf space in stores based on demand ultimately created by consumers. Consumers have the choice to go elsewhere, especially if prices get out of control. And while I love my afternoon venti iced coffee with milk, I'm sure there's a price I won't pay for it. (Though I can't come up with it right now; I'm too busy thinking about ducking out to go get my afternoon venti iced coffee with milk.)
Power of suppliers -- medium/high
Starbucks has a tremendous global operation and therefore must source its coffee from multiple suppliers. Furthermore, its commitment to using only the finest arabica coffee beans means that the company isn't going to settle for something of lesser quality. Given the volatility of coffee prices, Starbucks operates Farmer Support Centers to encourage best practices and also uses fixed-price commitments in order to help minimize price swings. But it doesn't stop there. Remember, Starbucks is not just coffee. So the entire supply chain operation of the company is crucial for the day-to-day operations of the company, and while it behooves suppliers to maintain the relationship, they definitely have some leverage here.
Industry jockeying -- high
In looking back to the power of substitutes, the point is obvious that this is an extremely competitive market and Starbucks needs to stay on its game to maintain its position and grow its global presence, as McDonald's, Green Mountain, and other coffee players have. And with tremendous opportunities in the instant coffee and single-serve markets, not to mention the grocer and packaged goods segments, I'd say there's plenty of work to do.
The future is now
From this perspective, Starbucks looks to be in a risky position. But I wouldn't have added it to the portfolio if I didn't think it had room to grow; in fact by any practical measure the stock didn't look like a screaming value at the time I bought it. But I do believe there are some companies that simply go beyond traditional valuation methods, whether because of a powerful brand or product or the management behind it all, or all of the above.
Given Starbucks' brand recognition and growing global presence, not to mention management that appears to be 100% devoted to the success of the business, I think there's still plenty of room to run for this coffee train. Agree? Disagree? Swing on by my discussion board and let's talk; you can also follow me on Twitter.
