Starbucks’ Earnings Preview: Entry Into New Beverage Segments & Full Ownership Of Japan Unit To Drive Future Revenue Growth

Starbucks Corporation (NASDAQ: SBUX) is scheduled to release its annual earnings report for the fiscal 2014 on October 30. ^[1] The coffee specialist has been an outperformer this year inspite of the bullish coffee run. The coffee futures are at 2.5 year high, as December Arabica-coffee prices rose nearly 80% over the last twelve months. ^[2] Moreover, the March coffee contracts touched $2.29 per pound on speculations of further dry conditions in Brazilian coffee producing regions. ^[3] From the start of this year, the drought conditions in the South American region has been ruining crops, pushing their prices up. Apart from the rising coffee prices, the quick service restaurants (QSRs), such as McDonald’s (NYSE:MCD), Dunkin’ Brands (NASDAQ: DNKN) and Burger King Worldwide (NYSE:BKW) are facing declining traffic and tough competition from fast casual restaurants.

In the third quarter, the company’s global comparable store sales rose 6% yet again, marking its 18th consecutive quarter with above 5% comparable sales growth. The highlight of the company’s impressive performance in this quarter was its U.S. comparable sales growth of 7%, despite increasing competition in the breakfast segment and rising commodity prices. Each of the company’s reporting segments delivered excellent performance in Q3, leading to an 11% increase in revenues to $4.2 billion. ^[4]

We have $82 price estimate for Starbucks, which is 8.5% above the current market price.

See our full analysis for Starbucks Corportion

Price Hike To Drive Sales Growth

In response to the soaring coffee prices, Starbucks raised the prices of its coffee menu in the third quarter. The company raised prices on some of its drinks by 5 to 20 cents, whereas it raised prices of its packaged coffee sold in supermarkets and other retail stores by $1 (8%) to $9.99 per bag. Starbucks’ coffee prices are already high as compared to its peers, but the company targets a more affluent demographic of coffee drinkers that typically exhibit strong brand loyalty, making demand for its coffee more inelastic with respect to price fluctuations. Starbucks’ competitors, such as Dunkin’ Brands(NASDAQ: DNKN), Peet’s Coffee and J.M. Smucker decided to raise their coffee prices in June. After ensuring that majority of the customers were aware of the reasons for the hike and the possibility of losing customer traffic was minimal, the company did not hesitate to raise its coffee prices.

Beverages account for the majority of the company’s total retail sales and accounted for 74% of Starbucks’ total retail sales in 2013.

Full Control Of Japan Unit To Boost Starbucks’ Revenue Growth In Asia

On September 23, the Seattle-based coffee giant announced to acquire the remaining 60.5% of Starbucks Japan through a two-step tender offer process for about $914 million. ^[5] Before this announcement, Starbucks had a 39.5% ownership interest in Starbucks Japan.

Japan, which is Starbucks’ second largest market with over 1,000 restaurants, is a lucrative market for coffee companies, as it is the third highest coffee consuming nation in the world after the Unites States and Germany, as of 2013. ^[6] The consumption of canned coffee in Japan has been constant with a significant increase in the consumption of roasted and ground coffee.  (See Starbucks’ Full Ownership Of Japan Unit To Boost International Revenue Growth)

In its 2013 annual report guidance, the company mentioned that it is increasing its operational activity in China and Asia-Pacific (CAP) for revenue growth. With the full ownership of a Japan unit, the company might accelerate its new store openings in the country to increase its customer base. According to our estimates, if the company doubles its pace of new store growth, the store count in Japan might reach 1,120-1,130 by the end of fiscal 2015. Increased number of outlets might translate to increased number of customers, and might boost the company’s revenue stream.

The company also looks at this deal as an opportunity to expand its product sales through food service channels, to accelerate its retail sales and to provide a boost to its small share of RTD products that are popular in Japan.

Expansion In New Beverage Segments

Starbucks is already one of the dominant forces in the coffee industry, with 13% of the single-serve coffee market, behind only Keurig Green Mountain (NASDAQ:GMCR). Apart from its renowned coffee stores, the company also owns and operates other brands such as Tazo, Seattle’s Best Coffee, Teavana, Evolution Fresh and La Boulange. Moreover, Starbucks introduced three new carbonated drinks under its Fizzio brand- Spiced Root Beer, Golden Ginger Ale and Lemon Ale.  Unlike existing at-home carbonation products where the machine carbonates the water and flavours are added afterwards, Fizzio carbonated drinks are finished beverages, with every ingredient receiving the same amount of carbonation. With its tea segment and recently introduced cold carbonated beverage segment, the company is entering into lucrative markets with completely different target customers. Both the new brands provide excellent platforms for the company to expand into bigger markets, apart from its coffee business. (See Starbucks To Enter Into New Beverage Segments With Teavana & Fizzio Brands)

Starbucks would have a hard time establishing its brand at a large scale in this market. However, it is still a big market and will provide incremental revenues for the company with a steady growth.

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1. FY14 Q4 Starbucks Earnings Conference call [↩]
2. Coffee futures charts [↩]
3. Brazil drought drives up coffee prices [↩]
4. Starbucks Q3 2014 earnings call transcript [↩]
5. Starbucks poised for continued growth and innovation in Japan through full ownership of company’s second-largest market [↩]
6. Inventories of Green coffee at the end of the year, International Coffee Organization [↩]