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Starbucks - 3 Reasons Why You Should Ignore Yesterday’s Drop
Posted by: Sarfaraz A. Khan (IP Logged)
Date: December 11, 2013 10:46AM

The shares of the world’s leading coffee shop chain, Starbucks (SBUX) dropped by as much as 3% yesterday to its lowest levels since mid-October following the ITG Investment Research’s report. The firm believes that the coffee maker’s momentum could be slowing down. Its same-store sales in the U.S. could increase by 5% to 6% in the first quarter of the next year, which is below market’s expectations of a 6.6% gain. However, this short term dip could be a buying opportunity for long term investors. The firm has a history of strong performance and has attractive long term growth prospects. The company has recently reaffirmed its guidance for 2014. The EPS is expected to be in the range of $2.55 to $2.65 while revenues could grow by 10% in 2014. Moreover, the profitability could also improve with an expected 150 to 200 basis points increase in the operating margins.

I believe that there are three main factors that will drive the company’s growth, as well as improve its profitability, through 2015: the favorable coffee pricing environment, the expected growth in some of its key markets and the increasing focus on tea and tea-related products.

1. Falling Coffee Prices

For companies like Starbucks, a drop in global coffee prices gives a boost to the bottom line. The drop in coffee prices over the last two years was the result of excess supply. In 2011 to 20112, the Arabica market faced a surplus of just 800,000 bags, which ballooned to 7.4 million bags in 2012 to 2013. Moreover, with the increasing output from Brazil and the expectations of larger crops from Colombia, coffee’s supply will continue to exceed demand in the coming year.

Starbucks uses Arabica beans and according to the International Coffee Organization, Arabica prices have fallen by around 30% this year due to the high yield harvest in Central and South America and a surplus in Brazil. Since Starbucks’s purchase contracts are drawn in advance, the positive impact of the current drop will be reflected in next year’s results.

This was one of the reasons behind the operating loss in 2012, which was attributed to the peak levels of Arabica prices in 2011. With significantly lower Arabica prices (down from $2.82 per pound in April 2011 to $1.14 per pound in September 2013), Starbucks has enjoyed, and will continue to enjoy, the favorable pricing trend.

The company’s management believes that this current weakness in the coffee pricing environment could give a $110 million to $120 million boost to the company’s earnings in 2014 and will have another “positive but lower” impact in 2015.

These changes in coffee prices have an industry-wide impact on other companies as well, such as Green Mountain Coffee Roasters (GMCR), J.M. Smucker (SJM), Caribou Coffee (CBOU) and Coffee Holding (JVA) as well as the iPath Dow Jones UBS Coffee ETN (JO).

2. Prospects in Key Markets

In 2013, Starbucks delivered extraordinary performance in some of its key markets where it has potential for significant growth over the long term. In China, its stores that opened in 2012 are now showing promising average sales of more than $700,000. Similarly, it opened 317 stores this year in the country and those stores are also on track to post similar sales numbers in the near future.

Some of the other markets, such as Indonesia, Korea, Thailand and Japan, are also showing encouraging results. Moreover, the company is expected to grow rapidly in the Indian market through its partnership with Tata.

In its previous fiscal year ending September, Starbucks posted a 27% increase in revenues from the China and Asia Pacific (CAP) to $721.4 million. This is a high margin operation from where Starbucks generates more than 30% operating margin. In this region, its margins could fall to low 30% range in 2014 but despite this, CAP will remain a high margin operation. Here, the company will open around 750 new stores in 2014, which will give a boost to its profitability.

3. Tea

Starbucks is also focusing on the expansion of the Teavana retail platform, which has significant growth prospects, particularly outside of North America. For instance, in Europe, where tea consumption is quite high, the growth of Teavana could support the company’s struggling coffee business in the continent.

Tea is still a very small part of Starbucks and represents less than 1% of the sales, but with Teavana stores, coupled with Teavana’s products being sold in Starbucks outlets around the world, this unit could become a major growth area outside of coffee. Teavana’s presence in Starbucks stores is going to fuel the brand awareness of tea which will drive the traffic growth of the Teavana stores. By the end of 2020, Teavana could add $5 billion in incremental value.


Starbucks F4Q 2013 Results - Earnings Call Transcript

Disclosure: This article was written by Sarfaraz A. Khan, with valuable contribution from Gohar Yousuf, research assistant at Half Bridge Business Review. Neither Sarfaraz A. Khan, nor Gohar Yousuf have any positions in the stock(s) mentioned in this article.

Stocks Discussed: SBUX, GMCR, SJM, CBOU, JVA, JO,
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