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Starbucks Corporation Bakes Growth Into Its Future

By Rich Duprey – Jan 26, 2014 at 4:30PM

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Coffee maker jolts results by expanding its food menu.

While the markets liked Starbucks' (SBUX 0.70%) caffeinated first-quarter results the other day even though its growth trajectory slowed, the real place to look to see where the java slinger is expanding is its food business.

Building on its $100 million acquisition in 2012 of La Boulange, a small San Francisco bakery and cafe it's using to provide baked goods to all its 20,000 coffee shops, Starbucks is seeing the opportunity to add a croissant or Danish to every coffee sale as a means of boosting sales. It's a multiyear rollout that currently has the baked goods sold in around 3,500 of Starbucks' company-operated cafes, or about a third of the U.S. total.

While I've previously wondered about whether the move by Starbucks to become a more broadly defined food and beverage company would be effective, analysts have questioned the impact it would have on operations and questioned whether the drop in same-store sales experienced last quarter was a result of baristas' need to spend more time warming up baked goods, thus slowing down service.

The coffee shop quickly stamped out the notion that the modest decline in comps from 7% last year to 5% this year had nothing to do with its baked goods but rather the decision by consumers to do more online shopping instead of visiting bricks-and-mortar stores this holiday season. CEO Howard Schultz calls it "a myth that absolutely has no legs."

Despite my reservations about its mixed marketing strategy, I'm inclined to agree, since McDonald's (MCD 0.13%) has suffered a meltdown of global proportions, reporting that December sales tumbled at a much steeper rate than expected, which it blamed on poor weather. While there is a certain dichotomy present in the type of customer who will buy coffee at Starbucks and one who will pick up a cup at McDonald's or fellow value brand Dunkin' Brands (DNKN), they're all still subject to the same larger market forces affecting consumer spending.

Even so, they're leading an expansion boom, with Dunkin' having added 790 stores last year and planning on adding as many as 800 more this year. Similarly, Starbucks opened 680 stores in the Americas, 588 in China and the Asia-Pacific region, 100 in Europe, the Middle East, and Africa, and 333 in all other areas. While Krispy Kreme Doughnuts (KKD) is also undertaking some major expansion, signing a multiyear development agreement to open 23 stores in China's southeastern province of Guangdong, it's also offered up weak guidance and has lost nearly a third of its value over the past two months.

So Starbucks is moving more toward a place where it resembles its rivals in their offerings but comes at it from a better place. It notes that wherever it has introduced its revamped food menu, croissant sales have doubled. It also anticipates that future growth prospects are just as rosy, as its deferred revenues surged 29% to more than $1 billion as gift card sales spiked over the holidays. Together with its mobile app, the two payment options represent more than 30% of Starbucks' total U.S. payments, giving it a technological edge as well.

I think there's a word of caution that needs to be said about that, as the coffee shop recently admitted that its mobile app stores a user's mobile-payment app password, username, and geolocation tracking points in unencrypted plain text, making it easy to hack into and use the account. In the aftermath of the Target hack attack debacle, there might be some consternation about the program, especially since Starbucks management had a rather cavalier attitude about the risk.

For the first time in years, Starbucks saw food as a percentage of total sales rise, and it now represents a fifth of all revenues, up from 19% for the past few years. As La Boulange continues to roll out over the entire store footprint, that figure will continue to rise, but even though I've cautioned that it may be necessary to change how we value Starbucks, at the moment it doesn't appear we should bake anything into our forecasts other than continued growth.

Fool contributor Rich Duprey has no position in any stocks mentioned. The Motley Fool recommends and owns shares of McDonald's and Starbucks. We Fools don't 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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