Investors largely cheered the latest report from Starbucks(NASDAQ:SBUX). Shares of the coffee giant rose 6% and hit a record last Friday due to better than expected fiscal first quarter earnings. The company grew revenue and profits, and the solid quarter capped off a very successful 2014. Starbucks reaped the benefits of its aggressive pricing strategy enacted last year, which was met with a good deal of controversy at the time.
Critics contended that consumers don't take price hikes lightly, and that it was foolish to increase prices and risk alienating customers in an economy that remains fragile for so many. However, this argument was proven dead wrong. Here's how Starbucks' pricing strategy directly led to its outstanding earnings results.
First, a quick review
Total sales grew by 13% year-over-year to $4.8 billion. Comparable, or "same-store" sales, which encompass locations open at least one year, also increased by 5%. Adjusted earnings clocked in at $0.80 per share, up 16% year-over-year. Both total revenue and adjusted earnings per share were right in line with analyst estimates, according to S&P Capital IQ.
The top line benefited from a combination of rising traffic and continued store openings. Guest traffic at comparable stores increased 2% globally. In addition, Starbucks opened 512 new locations during the quarter, with many of those locations in emerging markets. The coffee chain is making great strides in its international business, as the company achieved 8% comparable sales growth in its China and Asia-Pacific region.
Starbucks also hit it out of the park for the holidays. According to management, one of every seven Americans received a Starbucks gift card during the holiday season. The My Starbucks Rewards program now has over 9 million members after another 896,000 signed up last quarter.
The wonder of pricing power
Starbucks announced midway through 2014 that customers would pay $0.05 to $0.20 more for some of its in-store beverages. Furthermore, the retail price of packaged Starbucks coffee bags sold in grocery stores went up by about $1. The company took a lot of heat for this decision, but it was a necessary response to rising coffee prices. The price of Arabica beans had increased more than 50% leading up to the price move. In such situations, companies must make a difficult decision: Either pass on those higher costs to customers or eat the costs and suffer margin erosion.
Starbucks chose the former, and operating margin came in at 19.5%, which represented an 80 basis point expansion from the same period last year. Margins continue to grow simultaneously alongside increasing traffic and average ticket. There is little to suggest the price hikes last year hurt the company -- the exact opposite occurred.
The main takeaway here is that premium brands command pricing power, and it would be foolish not to leverage this when conditions warrant doing so. Starbucks is a premium coffee, and customers proved their willingness to pay more rather than seek out cheaper alternatives. While consumers are broadly price sensitive, the power of the Starbucks brand largely mitigated any negative effects of their aggressive strategy.