Like Em, or Hate Em, Starbucks is Going to Be a Bigger Company 3, 5, and 10 years from Now

Like Em, or Hate Em, Starbucks is Going to Be a Bigger Company 3, 5, and 10 years from Now

(Full Disclosure: Yale Bock, YH & C Investments, and its clients own positions in Starbucks. You should not buy SBUX stock based on this article and you should do your own research on the fundamentals of SBUX business, read its annual report and 10-Q, and assess your own portfolios objectives, constraints, time horizon, tax situation and any other pertinent facts before adding SBUX to the equity position in the context of a reasonably diversified portfolio).

Starbucks is going to be a larger company 3, 5, and 10 years from now. The main reason Starbucks will grow is because coffee and tea are both enormous markets, domestically and globally. Second, Starbucks has low penetration rates in terms of the number of locations it has, especially in the BRIC countries. Finally, Starbucks has nice potential for growth in packaged coffee, ready to make beverages, and the instant coffee markets, especially internationally.

Coffee is an incredibly large market, domestically and globally. According to coffee-statistics.com, in the United States 400 million cups of coffee are consumed daily, or 146 billion cups per year, making the United States the leading consumer of coffee in the world. According to the Buck County Coffee Company, there are 1.4 billion cups of coffee sipped per day, making it one of the most consumed beverages in the world. You may prefer McDonald’s, Dunkin Donuts, Peet’s Coffee & Tea, Panera Bread, or an independent house’s coffee, but I believe the coffee market is so large that there is more than a reasonable chance that Starbucks will be able to continue to grow it’s revenues and profits in the coffee segment.

Tea is also a huge market and one that SBUX participates in through its Tazo line and a partnership to sell a ready to drink tea beverage with Unilever. According to the Tea Association of the United States, wholesale tea sales grew from $1.84 billion in 1990 to $6.85 billion in 2007. Global tea production will rise to close to 4 billion kg by 2010, according to Kaison Chang, senior economist for commodities at the Food and Agricultural Organization at the 2nd Global Dubai Tea Forum in 2008 (Pg 2, India E-News). With the enormous brand recognition Starbucks has built all over the world, it is reasonable to expect Starbucks to grow and even increase its share of the surging tea market.

Working in tandem with the huge markets of coffee and tea, Starbucks has a low penetration of stores relative to the global market for coffee. Consider the fact that Italy, a country with a population of 58 million people, has over 200,000 coffee bars (Admittedly, Italy a very high ratio of number of people to coffee bars-1 for every 290 people.). Take a look at the following table and you can easily understand how much potential Starbucks has to grow its store base.



(From Starbucks Web Site) Starbucks: Huge Markets (Factbook 2008)

# of Starbucks Locations
(As of Sep 27, 2009) Country Population
Licensed-505
Owned-191
Total- 696 China 1.3 billion
None
(Regulatory Issues) India 1.15 billion
Owned-6,764
Licensed-4364
Total- 11,128 United States 300 million
Licensed- 74 Indonesia 240 million
Licensed- 23 Brazil 200 million
Licensed-19 Russia 140 million
Licensed-261 Mexico 110 million
Owned-144 Germany 82 million
Licensed-123 Turkey 72 million

If you consider that SBUX has stores in countries like Switzerland, France, Egypt, Saudi Arabia, and the Netherlands that are not included in the table (Starbucks has stores in over 50 countries), you can very easily grasp my point that the store base could easily double or triple from the current number of 16,535. The company has said over the next few years it will grow its store count more internationally than domestically. By doing so, more revenue will come from equity investees. In each of the last two years, income from equity investees has represented approximately 21-22% of operating income (2009-(121.9 million/562 million), 2008- (113.6 million/503 million)). Obviously, Starbucks and its partners will try to open locations in countries where the returns on invested capital are the highest.

Other areas for continued growth are the packaged coffee segment, the ready to drink beverage segment, and in the 21 billion dollar instant coffee market, where Starbucks recently introduced its new VIA product line. In all of the countries where Starbucks has a presence, it does not necessarily sell packaged coffee, ready to drink beverages (through its partnership with Pepsi), or instant coffee. A country like Brazil, Russia, or China could conceivably have a tremendous market in any one or all three of these categories. Tying into these areas is the continued growth of the Starbuck’s card, a way for Starbucks to communicate with customers through social networking, texting, email (coupons for instant coffee, special promotions, nearest location, etc) and on line video. The potential to use the card in any of the 50 or so countries where Starbucks has a presence is a huge asset and certainly will be invested in.

Lastly, a couple of other factors should help improve Starbucks ability to grow their revenues and profits. First, with the overcapacity in real estate, as the percentage of retailers that default increases, a large tenant like SBUX gains leverage with commercial developers in their ability to find great locations. Great locations are a long term competitive advantage for SBUX, especially if they can get them at attractive lease rates. Second, Starbucks has taken restructuring charges of 269 million dollars in 2008 and 332 million dollars in 2009 as they had to close down underperforming locations. Assuming there are no more charges, just not having these charges will help the bottom line. All in all, you may like Starbucks, or you may hate Starbucks, but it is hard to argue that 3 years, 5 years, or 10 years from now, Starbucks will be a larger and more profitable company.

As always, on any company mentioned here, past performance is not a guarantee of future returns. One should research any investment and make sure it is suitable with your objectives, risk tolerance, risk profile liquidity considerations, tax situation, and anything else pertinent to your financial situation. Also, the CFA credential in no way implies investment returns will be superior for any charterholder.

Yale Bock, CFA
President, Y H & C Investments