Starbucks to grow grocery business tenfold

The coffee giant expects sales from food stores and retail outlets to rival revenues from its coffee operations.

By TheStreet Staff Mar 25, 2011 2:08PM

By Miriam Marcus Reimer, TheStreet

 

Starbucks (SBUX) worked to hold on to the week's gains Friday after the coffee giant said Wednesday that it expects sales of its coffee and other products at grocery stores and retail outlets to one day rival its traditional coffee shop business -- meaning the operating segment would grow more than tenfold from its 2010 results.

 

On March 23 at Starbucks' annual shareholder meeting in Seattle, CEO Howard Schultz promised investors huge growth in the company's grocery business, less than a month after Starbucks' 12-year arrangement with Kraft Foods (KFT) ended.

 

Starbucks shares were trading 1% lower at $37.21 Friday afternoon, working to hold on to gains of 5% on Wednesday and 2.4% on Thursday.

Its coffee shop and retail business brought in $8.96 billion last year, accounting for around 84% of its net $10.71 billion in revenue, while its global consumer packaged-goods business garnered just $707.4 million in sales, or around 7%.

 

"The CPG (consumer packaged-goods) business as we know it today will rival the success of our Starbucks retail business" at some point in the future, Schultz said at the shareholder meeting in Seattle.

 

Deutsche Bank (DB) analyst Jason West resumed coverage of Starbucks shares Wednesday with a buy rating and $41 price target, representing a 17.3% upside to Tuesday's closing price. The analyst sees increasing momentum for Starbucks after spending the last couple of years focusing on its core business rather than growth.

 

Morgan Stanley (MS) analysts increased their price target by $2 to $42 on Wednesday, implying a 20.1% upside to Tuesday's closing price.

 

Starbucks is banking on using is emblematic brand name to help peddle a wide array of consumer products such as its Via instant coffee, bottled Frappuccino and Starbucks and Tazo tea-branded K-Cup single-serve pods for Green Mountain Coffee Roasters' (GMCR) popular Keurig machines.

 

"We are now playing from a position of strength," CFO Troy Alstead said at the meeting.

 

Deutsche Bank's West noted that "we still see room for further upside in coming quarters, as U.S. momentum continues, international gains traction on both unit growth and margins, and (consumer packaged goods) hits an inflection point."

 

Starbucks has made moves to expand beyond its traditional coffee shop business recently, starting with the launch of Via instant coffee packets in 2009. In February Starbucks said it reached a distribution agreement with Courtesy Products, a privately held provider of in-room coffee service to hotels across the U.S. Then on March 10 Starbucks and Green Mountain announced a much-anticipated partnership in the single-serve coffee market .

 

Meanwhile, Starbucks rolled out a new wordless logo this month, unveiled on Jan. 5. Removing the words "Starbucks Coffee" from the iconic logo came as the company celebrated its 40th anniversary, providing Starbucks with "the freedom and flexibility to think beyond coffee," according to Schultz' statement at the time.

 

Expanding further into the $1.6 billion single-serve coffee market is sure to be a big part of Starbucks' ambitious goals; the company said two-thirds of the growth in the U.S. coffee market over the last year has been in the category.

 

Part of the now-defunct Starbucks-Kraft agreement involved Starbucks providing coffee discs for Kraft's Tassimo single-cup home brewers. Despite Tassimo's success with some consumers, Green Mountain's Keurig brewing system enjoys market share of around 80%, according to Reuters, dominating other competitors as well, including Sara Lee's (SLE) Senseo brewer and Nestle SA's (NSRGY) Nespresso system.

 

As part of its deal with Green Mountain, Starbucks will sell the Keurig machines in its stores and through specialty retailers as early as 2012. Starbucks expects the deal to generate around $1 billion.

Starbucks will also sell a single-cup brewing system through its partnership with Courtesy Products.

 

Starbucks' partnership with Autogrill's (AGL) HMSHost to operate its cafes in U.S. airports and elsewhere was just extended for another 10 years.

 

The Seattle company does not plan to neglect its traditional café business, however. It hopes to connect further with customers by offering a pay-by-smartphone system, and boost store traffic through social networking tools. It also announced plans to augment its in-store Wi-Fi offerings by providing customers access to subscription sites like The Economist, ESPN Insider Rumor Center, Marvel Digital Comics and Mediabistro, hoping to keep customers in stores longer and ultimately buying more beverages and other products.

 

Starbucks may also be eyeing growth through acquisitions, though Peet's Coffee (PEET) is likely not a target.

 

Reports began circulating on March 15 that Peet's and Starbucks recently held talks to discuss a potential sale. Details remained limited but Starbucks CEO Howard Schultz has indicated the Seattle coffee giant would look to make an acquisition, likely sometime this year.

 

"Though there have been no reports of any formal announcements regarding any merger or acquisitions from either companies, the analysts and industry sources claiming familiarity with Starbucks anticipate the takeover of the Emeryville, Calif.-based Peet's specialty coffee retailer and roaster by Starbucks," noted Zacks Equity Research.

 

At Starbucks' annual shareholder meeting on March 23, the company denied such rumors, saying that any speculation it might announced an acquisition of Peet's was wrong.

 

Peet's has said it would look to make a move into the single-serve coffee market, a growth area Starbucks also plans to penetrate, as evidenced by its recently announced partnership with Green Mountain.

 

Peet's would be an attractive target for Starbucks, some analysts say, given its mature distribution network and premium pricing. The pair already shares some history, too; Peet's was Starbucks' original coffee bean supplier in 1971, according to the Financial Times.

 

"If Starbucks buys the coffee roaster, it can use Peet's relationships with major retailers, who will allow a "triad of premium brands" on store shelves, with Peet's offering super-premium, Starbucks as premium and Starbucks' secondary brand Seattle's Best Coffee positioned as "fighting" premium," Zacks noted.

 

"Peet's Godiva-flavored coffees would also give Starbucks leverage if it enters the single-cup brewer market, which many perceive as a huge area of growth in the coffee industry," the firm added.

 

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