In the past 25 years, Starbucks (SBUX 0.07%) has transformed itself from a local roaster and coffee shop chain in Seattle to a globally recognized brand with more than 18,000 cafes worldwide. This transformation has created a company with annual revenue of more than $13 billion. Nevertheless, Starbucks has continued averaging double-digit revenue growth. As a result, Starbucks stock has managed to maintain a generous P/E ratio above 30. Can the company keep growing fast enough -- and long enough -- to justify this valuation?
While Starbucks is already the biggest name in the coffee business, the company still has three big growth opportunities. First, it can expand geographically, by adding new cafes in underserved areas. Second, it will expand its reach beyond coffee. Third, it will expand its consumer packaged goods business, leveraging its global brand awareness. These three growth initiatives create significant upside for Starbucks stock over the next five to 10 years.
Starbucks keeps growing
While Starbucks already operates more than 18,000 cafes, the vast majority of these are in the Americas, and particularly the U.S. Nevertheless, the company continues to see opportunities to expand in its core markets, and plans to open more than 3,000 cafes in the Americas over the next five years, with more than half of those in the U.S. Domestic expansion has not caused any significant cannibalization of existing stores, as Starbucks continues to post healthy same-store sales growth.
Eventually, the company will saturate the U.S. market with its signature cafes. Fortunately for Starbucks stock owners, the company has plenty of room for growth overseas. China is the biggest opportunity: Starbucks plans to make this the company's biggest market outside the U.S. by doubling the number of cafes it operates in China to 1,500 by 2015.
At an investor conference last year, CEO Howard Schultz stated that while it took Starbucks 10 years to really connect with native Chinese customers, the company now has strong momentum there. One tool that has helped it connect with customers there has been localization of product offerings. Looking forward, Starbucks wants to use its portfolio of tea brands to capitalize on the popularity of tea in China and other Asian markets, thereby strengthening its popularity overseas.
Tea and crumpets
Starbucks has always had tea offerings, but the company made a big move to boost its tea profile last year with the acquisition of Teavana. For Starbucks stockholders, the Teavana acquisition is great news because it gives the company an opportunity to grow in a new market that is similar in size to the global coffee market.
While Teavana has traditionally focused on selling loose-leaf teas, Starbucks intends to open "tea bars" within Teavana shops to provide a Starbucks-like experience. Teavana beverages may also be sold inside regular Starbucks cafes.
The company is already increasing its non-coffee offerings within its cafes. In late 2011, it purchased Evolution Fresh, a fruit and vegetable juice maker. By the end of this year, bottled Evolution Fresh juices will be available in most U.S. Starbucks locations, replacing PepsiCo's Naked Juice.
Most important, Starbucks is in the midst of significantly upgrading its food offerings. Last year, the company bought La Boulange, a Bay Area bakery. Food currently represents just 19% of sales in domestic Starbucks cafes, and executives expect that La Boulange will open the door to offering a bigger selection of baked goods and sandwiches, while improving food quality.
Increasing food sales will allow Starbucks to leverage its fixed costs, like rent and utilities. On the other hand, food sales usually carry a lower gross margin than beverages. Nevertheless, Starbucks management expects the net effect to be higher operating margins and higher profit.
Beyond the cafe
The last, and potentially biggest, opportunity for Starbucks is consumer packaged goods. Starbucks believes that its "channel" business could one day be as big as its cafe business, despite representing less than 10% of revenue today. If this vision eventually comes to fruition, Starbucks stock will be a bargain at today's prices.
Starbucks plans to build all of the brands that it owns -- including its recent acquisitions -- into well-known, highly respected franchises. It is already the leading premium packaged coffee brand, but management wants to grow the company's packaged coffee market share while also creating a major presence in the tea and juice markets. The CPG channel offers higher margins than the cafe business, so it could become a significant profit driver for Starbucks as it grows.
Foolish conclusion
While Starbucks already seems ubiquitous, it actually has significant growth opportunities ahead. Starbucks stock does fetch a valuation premium to the market, but it has a talented management team lead by Schultz. There may be some bumps along the road, but the company's initiatives to diversify into new geographies (especially China), new product lines (tea, juice, and baked goods), and new distribution channels will position it for growth. For long-term investors, Starbucks stock looks like a solid investment opportunity.
