Innovation is not new for Starbucks (SBUX, Financial) as the chain has continuously strived to bring about efficient product innovation and please its customers across the globe. In fact, the incessant innovation practices has been behind the phenomenal growth that this chain has achieved over the years. Currently, Starbucks is the largest coffeehouse company in the world, ahead of its UK rival Costa Coffee, with approximately 23,305 stores in more than 60 countries and territories. Now, the coffee giant has cooked up another innovative coffee i.e a beer-flavoured coffee drink called the dark-barrel latte. This non-alcoholic brew gets its Guinness-like taste from a stout-flavoured syrup and dark caramel drizzle and is also available in a Frappuccino.
Product innovation continues
Though this new dark-barrel latte is only available in select locations across Ohio and Florida, people have already started giving their reviews on the product. For now, the statements given by people suggest a mixed reception as it ranges from “yuck” to “I might be in love with this coffee”. The company has remarked that the new flavor was “inspired by the rise of craft beers” and that the taste is meant to mimic a “roasted malt flavor.” Before launching this initiative, Starbucks had already been offering beer at several locations through its evening menu. In fact, the evening menu aims to offer a holistic spread to customers to invigorate their taste buds.
Besides the beer-flavored latte, the company is also experimenting with “mini” size Frappuccino in select stores in Denver and Houston. This will definitely attract consumers who are health conscious and inclined to reduce the sugar and fat content in their coffee. Now, departing from the coffee side of it, I would like to spend some time in discussing Starbucks’ strategy with tea market. As we know, the company acquired Teavana in 2013 with an intent to establish the brand in British and Asian regions, where the consumption of tea is higher as compared to the U.S.
As per the Q3 earnings call, Starbucks introduced both Teavana Oprah Chai and Teavana Shaken Iced Tea to tremendous customer response. It is quite clear that the management of the company is attempting to build a completely new category of beverages with Teavana brand and if becomes successful in doing so, then it will become one of the few leading retailers to have organized tea products on such large scale. Starbucks CEO Howard Schultz mentioned in its recent Q3 earnings call conference that the company believes the tea market is worth $90 billion and this gives them incentive to transform this segment into a core segment in the long run.
Don’t be worried for the price rise in coffee
As the media has reported earlier, coffee prices have doubled since late last year due to a severe drought in Brazil, the origin of roughly a third of the world's coffee. The dry spell wreaked havoc on this year's harvest of Arabica beans, which are used for the vast majority of global coffee production. As a result, the buyers of coffee beans including Starbucks are paying a high premium over the regular prices, the extent of which has even gone to 70 percent. Though there has been no official news for the company with regard to raising the price of coffee sold by them, it cannot be absolutely expected that it would not happen.
However, investors should not be worried with regard to the increasing prices because of the following two reasons. First, the sheer size of the scale at which Starbucks operates, makes it easy for the company to distribute the increase in costs over a large sales bucket. As a result, the price increase in coffee would not be more than a few cents and being an established brand, the demand elasticity for its products is naturally low. Second, the coffee giant has now expanded into different product lines and among them tea, customized food spread, etc., are getting traction. Hence, Starbucks is not heavily dependent on coffee to sustain its revenue and going ahead, the coffee product line will become one of many business units operating within Starbucks. Also, it is important to note that being a large-scale retailer, Starbucks had locked in its coffee costs for 2014 as well 40 percent of its needs for fiscal 2015 and has been insulated from the surge in price of coffee to a reasonable extent.
Takeaway
In my last article, I mentioned how Starbucks has strong fundamentals but also has an expensive price tag. Since that article, the stock has dropped around $2 in price from $77.18 to $75.18 but is still expensive at a forward multiple of 23.5 and PEG ratio of 12.98. Therefore, my advice will be to wait for some more time before making a new position in the stock. There is no doubt that Starbucks is a fundamentally strong company and has lucrative opportunities lined-up but it may encounter a pull back soon and once that happens, the stock will become an ideal investment choice.
