Starbucks (SBUX)

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WHAT HAS CHANGED?

Increase In Ticket Size Drives U.S. Comparable Sales Growth

For Q3 2017, Starbucks' U.S. comparable sales grew by 5% after a slow growth of 3% in the past two quarters. However this growth was only due to an increase in ticket size and the company did not see any increase in traffic in the region. It appears that the congestion problem caused by its mobile ordering and payment system is easing although no increase in traffic is a sign that the company still has to make improvements to make this system more effective. Revenues grew by 8% year on year in this quarter as the company continues to expand its restaurants globally.

China Continues To Drive Growth

China remains a key pillar of Starbucks’ growth. In Q3 2017, comps in China accelerated by 7% which were driven primarily by a growth in transactions as the company continues its aggressive expansion in the region.

Starbucks bets on Reserve Roastery and Tasting rooms to promote growth

Starbucks Reserve Roasteries are a way to showcase the newest coffee brewing methods and offer customers the finest assortment of exclusive micro-lot coffees from around the world, while continuing to innovate and experiment with new products such as nitro coffee, Affagato, and Teavana iced teas. The menu items in these Reserve stores are much more expensive than those in regular Starbucks stores.

The company has introduced Reserve coffees in over 1,200 regular stores worldwide, to drive additional customer traffic. Starbucks now serves Starbucks Reserve coffees in around 136 locations across 10 markets in China and the Asia-Pacific (CAP) region. It is planning to expand the availability of Starbucks Reserve coffees to over 1,000 locations. The roastery provides the company the opportunity to launch 500 Starbucks Reserve stores around the world.

Further, the success of the Seattle Roastery is an example of what the company hopes to achieve through these premium stores. Following the opening in Shanghai, it expects to open a roastery in New York City and Tokyo in 2018, and another in Europe in 2019.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Below are key drivers of Starbucks' value that present opportunities for upside or downside to the current Trefis price estimate for Starbucks:

Company Owned Stores

Company Operated Stores EBITDA Margin :The margins improved to 18.7% in 2010 from 16.5% in 2009 due to restructuring and store closures. However, in 2011, the margins dropped to 17.5%, primarily due to high coffee prices. In 2012, they remained relatively stable. In 2013, the margins increased to 20.6% as a result of low arabica coffee prices, and further to 22.3% in 2014. In 2015, however, coffee prices shot up resulting in margins again coming down to 21.9%, and further to 21% in 2016.While we expect the margin to remain in the range of 20-21% over our forecast period, higher coffee prices can impact the margin adversely. If the company's margins are pressured downwards to 18.0%, due to rising coffee prices there can be a 10% downside to the Trefis stock price. However, if the arabica coffee price rally halts and tests new lows, margins may improve to 26.0%, leading to an upside of 13% to the Trefis valuation.

BUSINESS SUMMARY

Starbucks is the world’s leading roaster and retailer of specialty coffee. Through its global network of owned and franchised coffee retail outlets, Starbucks offers a wide range of products like high-quality whole bean coffees, freshly brewed coffees, Italian-style espresso beverages, cold blended beverages, food items like sandwiches, premium teas, and coffee making equipment.

Starbucks' own stores are located near offices and residential areas and are larger in size, compared to its licensed stores that are much smaller and mostly located at airports and supermarkets.

Starbucks also sells its packaged coffee and tea through retail channels such as grocery stores, warehouse clubs, convenience stores, and US food service accounts.

SOURCES OF VALUE

The Company Operated Stores division is more valuable than the Franchise Stores division for Starbucks because of the following two reasons:

Company operated stores generate more revenues than franchised stores

Starbucks makes money through its company-owned stores as well as through franchise fees and royalties from franchised stores. Starbucks earns higher profit margins from franchised stores compared to company-owned stores because there are no operational and employee costs involved with franchised stores, hence Starbucks gets to keep the entire royalty & rent fee without paying for any costs.

Revenues earned from Starbucks' company owned stores are much higher than the franchised stores. This is because, although there are costs involved, Starbucks owns 100% of the revenues from its own restaurants, while it gets a percentage of the revenues (in the form of royalty fees) from its franchised restaurants.

Number of company owned stores comparable to franchised stores

Food & beverage companies, in general, increase their reach and profits by having a large base of franchised stores. For example, McDonald's has four times more franchised restaurants than company owned restaurants, making the franchise business more valuable to its stock. However, Starbucks has almost an equal number of company owned stores and franchised stores. As of October 2017, Starbucks had 13,275 company-owned stores and 14,064 franchised stores making a total of 27,339 stores.

KEY TRENDS

International expansion fueling growth

Most of the new restaurants the company plans to open are in China/Asia Pacific. The number of Starbucks outlets in these countries are only a fraction of what they are in the U.S. New outlets opened will be a mix of company-operated and franchised restaurants. The company plans to take the store count in China to 3,400 by 2019. Shanghai alone has 320 Starbucks stores. Starbucks plans to double the store count in China & Asia-Pacific to 10,000 by 2019. Moreover, the company decided to take full ownership of Starbucks Coffee Japan Ltd. (Starbucks Japan). On September 23, 2014, Starbucks announced its intent to acquire the remaining 60.5% of Starbucks Japan through a two-step tender offer process for about $914 million. Similarly, it plans to double the number of restaurants in South Korea to 700 by 2016. The company plans to accelerate the expansion in India in the coming years.

Ease and convenience of payment through mobile apps helping domestic sales

In Q4 2017, Starbucks' mobile order and pay reached 10% of transactions in its U.S. company operated stores. Consumers can load the money on to the app and then present a 2D bar code to pay at the register. With this app, it’s easy to pay with a phone, track purchases, and view one's My Starbucks Rewards Stars and rewards.

Starbucks Reserve coffee initiative boosts revenue growth

In December 2014, Starbucks introduced a new concept and opened the first ‘Starbucks Reserve Roastery and Tasting Rooms’ in Seattle. Moreover, the company has introduced Reserve coffees in over 1,200 regular stores worldwide, to drive additional customer traffic. Starbucks now serves Starbucks Reserve coffees in around 136 locations across 10 markets in China and the Asia-Pacific (CAP) region. Reserve coffees are more expensive than regular coffee items, and the company is trying to expand the initiative throughout the U.S. stores.

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