Starbucks turnaround still has legs

New stores, new markets, and new food and drink offerings underpin the coffee chain's long-term growth prospects.

By TheStockAdvisors Oct 29, 2012 1:44PM
A Starbucks Corp., sign is displayed outside a coffee shop in London, U.K., Chris Ratcliffe/Bloomberg via Getty ImagesBy Geoffrey Seiler,

Starbucks (SBUX) dominates the coffeehouse market worldwide; it also boasts one of the world's most recognizable brands.

Since Howard Schultz returned in 2008 to the helm of the company he founded, Starbucks has been a solid performer, especially over the last couple of years. The stock rose from around $32 at the end of 2010 to a high of $62 in mid-April 2012, before weakening to its current level near $46.

Long term, Starbucks hopes to perk up its domestic business by expanding the number of food offerings in its stores. In early June, it announced the acquisition of San Francisco-based Bay Bread and its La Boulange Bakery brand.

The strategy brings Starbucks into closer competition with the likes of Panera Bread in the bakery-cafe category, not to mention all the other quick-service restaurant operators out there, including McDonald's.

Food already accounts for about $1.5 billion of Starbuck's revenue from company-operated stores in the U.S.

Starbucks has also gotten into the fruit juice and smoothie category through the acquisition earlier this year of Evolution Fresh. The goal is to build a national health and wellness brand.

Europe was challenging for the company during the last quarter, as it has been for some time. Meanwhile, Asia-Pacific is the fastest growing region for Starbucks, which is now in 12 markets with more than 3,000 stores.

Starbucks opened 231 net new stores around the world in Q3, including its 600th store in Mainland China and its first stores in Costa Rica and Finland. Earlier this month, it opened a store in Mumbai, India, with plans to open five more.

Starbucks said it is well on the way to opening the 1,000 net new stores it planned for fiscal 2012. It expects to open another 1,200 net new stores in fiscal 2013, primarily in the U.S., China, and the Asia-Pacific region.

There is still coffeehouse growth potential in the U.S., which we think will be aided by the La Boulange deal.   

Baked goods and coffee are a natural fit. The expanded food offering, along with the addition of fruit juices and other non-coffee drinks, could attract customers at times when they otherwise might not have visited a coffee shop.

The company's move into the consumer channel (K-Cups, Via, etc.) is also a strategy we favor, especially given the strength of the Starbucks brand. K-Cups alone should add some nice growth.

Once new offerings like Evolution Fresh gain traction in Starbucks' stores, management will want to push them into the consumer packaged goods (CPG) channel as well.

The new Verismo single serve system, which will make Starbucks-quality espresso beverages and brewed coffee, could also turn into a nice winner.

Competition has increased with more companies like McDonald's entering the premium coffee business, but overall we think the Starbucks turnaround story still has legs.

With the stock well off its highs it has become more attractive, trading around 20 times the fiscal 2013 earnings per share consensus, ex its $2.57 per share in net cash.

Starbucks carries a premium to smaller competitors, but it should given the strength of the brand and the numerous levers it can pull to drive long-term growth.

The valuation is still a little rich for us, but this is a top-notch company that can be bought on dips.

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