VIA instant coffee was ridiculed when it launched, but it turned out to be a huge success in 2010. This and other reasons to be bullish on the coffee chain, even after its strong year.
It would be hard to dispute that fiscal 2010 was a strong and pivotal year for Starbucks. With about 60% of analysts now recommending the stock as a buy versus a low of about 30% in mid-2009 and with only 2% short interest in the name, I doubt few would try.
That being said, with the stock now trading at a higher multiple, there has been some question about whether the company can maintain its current momentum. Following Starbucks management presentations this week, I am even more confident in the company’s long-term growth prospects than I was previously.
Fiscal 2010: The Year of VIA
Although the VIA brand was only net neutral to earnings in fiscal 2010, the brand has enjoyed success in such a short amount of time — it generated about $135 million in global sales in the retail and consumer packaged goods (CPG) channels in its first year – which has given the company a renewed confidence in its ability to pursue new avenues of growth. The strong rollout of VIA has proven that the company can successfully leverage its retail store base to spur trial and awareness of a new brand in order to drive even more significant growth through the CPG channel (the basis for the company’s new “blueprint for profitable growth”).
Starbucks (SBUX) employed the direct distribution model for the first time with the VIA rollout and the approach yielded such strong results that the company has decided to use a direct model, in addition to its already established license and joint venture partners, for the entire CPG channel, effective March 1, 2011.
It has partnered with Acosta, a proven selling agent with nearly 100% coverage of the food, drug and mass channels in the U.S., to pursue this direct model approach and has ensured a smooth transition following the termination of the Kraft (KFT) distribution agreement.
Although I am concerned about issues that may surface during the initial transition phase, over time, it should prove beneficial for Starbucks to be more vertically integrated and, as the company highlighted, to have one marketing voice across the entire CPG channel. For reference, licensed sales of packaged coffee and tea mostly sold through the Kraft partnership accounted for 23% of specialty revenues in fiscal 2010 (or about 4% of total SBUX revenues).
Outside of the $1 billion VIA brand potential, the company is significantly investing behind Seattle’s Best Coffee in both the retail store and grocery segments (SBC rebrand and relaunch), Frappuccino and Tazo Tea, among others. These are all brands that the company thinks will drive tremendous upside over time, and again, leveraging trial runs within Starbucks’ retail stores will encourage growth.
Outside of developing brands organically and driving increased profitability of already established brands, Starbucks made it extremely clear that it would do an acquisition, either big or small, if it found a company that fit its business model. Specifically, Starbucks is looking at all options and wants to be a leader in coffee, in all coffee categories.
Diversified Growth Engines
U.S. – Although Starbucks recently closed hundreds of stores in the U.S. and significantly reduced new unit growth, management highlighted that the U.S., which currently accounts for about 70% of total revenues and operating income, will continue to be an essential component of ongoing growth. The company expects to add 100 net new stores in fiscal 2011 and accelerate unit growth in fiscal 2012 and beyond. Growth in the U.S. will expand beyond unit growth, however, as the company remains focused on growing business within its existing store base through new store designs, increasing drive-thru business, new products, increasing capacity and expanding dayparts.
International – This segment is expected to drive the next leg of growth for Starbucks as the company implements the lessons learned in the U.S. This growth will come from an increased focus on operations and improving execution within the existing store base as well as accelerated new unit growth (primarily licensed store growth).
On top of the expected 400 net new stores in fiscal 2011, the company specified that it is already investing now to build the real estate pipeline for 2012, 2013 and beyond.
- Established markets: Canada and Japan – These markets are healthy and well poised for growth now.
- Key European markets: UK, Ireland, France and Germany – These markets need work before accelerating growth.
- Emerging markets: China, Brazil, India and Russia – These markets provide tremendous growth opportunities but also require that Starbucks invest ahead of the growth curve. The company continues to think that China will become the second-largest market for the company outside of the U.S. (targeting 1,500 stores by 2015 from about 400 units now).
CPG – Following on the recent success of VIA, management seemed most excited about the potential of the CPG business. The company currently only generates CPG revenues in 10 of the 54 countries in which it operates. This, alone, is a huge opportunity for the company’s new direct model. Once the company builds the internal capabilities, Starbucks will have the experience and knowledge to move into any market with its CPG business. This, however, will take some time.
Eventually, management is convinced that as the CPG business growth accelerates, it will drive business back into its retail stores. The company even mentioned the potential for a loyalty card that would allow cross-shopping and rewards for purchases of Starbucks products in both the grocery and retail store channels.
Headwinds
Like anything else, however, there are some near-term challenges worth highlighting:
- Expectations are high: The street is at $1.49 per share for fiscal year 2011 relative to management’s $1.41-$1.47 guidance.
- Coffee prices are high: Management stated that coffee accounts for 15-20% of the company’s overall cost structure and that current prices are not sustainable. If coffee prices move higher, however, margins will come under pressure and management may have to again raise prices.
- The company is lapping its first quarter of positive comp growth in the first fiscal quarter of 2011.
- Kraft transition disruptions: Management has said it will be a smooth transition, but there are likely to be some hiccups.
- Consumption cannonball: A weakened consumer environment would likely impact the company’s current comp sales momentum.
