Three Trends Driving Starbucks’ Stock To $55

Starbucks Corporation (NASDAQ:SBUX) has had a bumpy year so far but has performed well overall with gains of more than 20% in 2012. In an event-filled year for the company, it has rolled out Starbucks Blonde domestically, announced its decision to expand aggressively internationally, acquired the bakery chain La Boulange for $100 million and recently announced its decision to open up tea stores under the brand Tazo tea. Here we discuss some of the major trends the success or failure of which could affect its stock price significantly.

See full analysis for Starbucks here

1. Coffee Prices

Coffee prices are critical to Starbucks’ profitability. Generally, coffee chains are often not able to raise the menu prices at the same rate at which international coffee prices increase. Furthermore, since the menu prices of Starbucks are already higher than most of its rivals (such as Dunkin’  Donuts and McCafe), a substantial rise in its prices can deter a significant proportion of its customers or force them to switch to more inexpensive options.

Moreover, the coffee prices greatly impact the profitability of its packaged coffee division (called CPG – Global Consumer Products). This is the division which gets impacted the most from coffee prices since the cost of coffee accounts for the chunk of the total cost. The revenues of this division exceeded $1 billion for the calendar year 2011 and is emerging as one of the most important segments for the company. Profitability of this division will influence the overall profitability.

2. Menu Pricing

Starbucks has big plans to open new stores in Asia and Latin America. Earlier in the year, Starbucks announced its plan to accelerate the store openings in China to 1,500 by the end of 2015. It will also double the number of stores in South Korea to 700 by 2015 and open its first stores in India in 2012 itself. Similarly, in Brazil, it expects to open several hundred new restaurants in the next five years.

Although these countries offer tremendous opportunity due to Starbucks’ low penetration, it is important to get the pricing right since developing markets are more sensitive to prices than developed ones. Starbucks’ menu prices in developing markets are on par with those in the U.S. Usually, most coffee chains and fast food restaurants have their menu prices lower in developing markets. A quick look at The Economist’s Big Mac Index emphasizes this point. For example, the Big Mac burger, which costs around $4.20 in the U.S. costs $2.44 in China.

High menu prices might help maintain profitability but will prevent the annual footfalls from growing at a healthy rate. Similarly, the rate at which new restaurants are opened could also be affected if the existing restaurants do not get the required response. Getting its menu prices right is a challenge for any company; it usually occurs through trial and error and over time but Starbucks will have to be open to the idea of surviving on thin margins to compete against local coffee chains to sustain long-term growth.

3. Success of New Ventures

Starbucks’ strategy for the U.S.is different than that for its international operations. Due to its near ubiquity in the U.S., there isn’t much scope to expand traditional coffee stores. In fact, Starbucks shut some of its stores in the U.S. from 2008 to 2010 to lower the number of under-performing stores and to reduce cannibalization. Since then, it has been delving into new ventures in the hope of turning each of them independently into multi-billion dollar ventures.

Focus areas have been juices, bakery and specialty teas. The idea is to offer products (under different and independent brands) which are less likely to eat into each others’ sales and to appeal to the new-age consumer who is usually more health conscious. Examples include the acquisition of Evolution Fresh juice (after which it named its first juice bar in March this year), the recent acquisition of La Boulange bakery and its decision to open tea bars under the brand name Tazo. Once these brands are associated with a high quality experience, Starbucks can leverage their respective brand names to expand into international territories. This will require considerable time as well as investment from Starbucks’ point of view therefore any deviation from expectation could affect the profitability and consequently the stock price.

We have a $55 price estimate for Starbucks currently, which is slightly above the current market price.

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