SBUX – DRINKS WITH INTEGRITY

Yesterday, SBUX was up 1.3% on light volume but the nature of the announcement that the company made intra-day is bigger that the reaction in the stock price implies.  Understanding that the implications on the P&L are years away, the call yesterday with senior management yesterday made it clear to us that it was a significant event for the future of the company.  The announcement was made when the restaurant analyst community was in Oak Brook at the McDonald’s Analyst Meeting.

 

In announcing the acquisition of the Evolution Fresh Juice Company for $30 million in cash, Starbucks gave a clearer picture of the blueprint for future of the company’s “organic” growth beyond the coffee category.  Unlike other retail companies, the Starbucks brand (changed the logo last year to be less coffee-specific) already competes in a number of different retail categories, so moving into the juice category was hardly a conceptual leap. Starbucks is using this acquisition to “build a broad-based multi-billion-dollar health and wellness category” under the Starbucks logo.

 

According to Starbucks, the category of Health and Wellness is a $50 billion category (US Coffee market is $38 Billion) and the acquisition of Evolution is to provide the foundation for the company’s entry into the business.  Starbucks’ intention is to “re-invent” the category in the same they re-invented the coffee market.  While I understand the company’s goal here, the comparison is not necessarily the same.  The coffee segment lacked real innovation and was declining before Starbucks came along.  The juice and the overall health and wellness category are growing rapidly and are seeing new innovation on an ongoing basis.  To that end, just what Starbucks has up its sleeve will be important for how this plays out.        

 

Evolution is not a concept we are overly familiar with but clearly it has been carefully selected to be the launch pad for a much larger strategic move.  The High Pressure Processing technology that Evolution uses to pasteurize (without heating) its juice was a key characteristic pointed out by management in the press release and during the call yesterday as a differentiator for Evolution within the juice category. 

 

HPP is a method of food processing where food is elevated to pressures of up to 87k lbs per square inch with or without the addition of heat.  The method retains food quality, maintains natural freshness, and extends shelf life.  Fans of the methodology contend that HPP provides juice drinks that are the equivalent of getting fresh-pressed juice with an extended shelf life. 

 

Initially the Evolution Juice product and brand will “live nationally” in Starbucks stores and experience a sampling and trial to judge consumer acceptance.  Assuming a successful introduction, SBUX will build a national business through its CPG channel.  In addition, management intends to begin opening up a retail footprint towards the end of the first half of calendar 2012.  Over time, it’s management’s intention to have a national footprint of health and wellness stores.  Starbucks’ bold plans are to build the first consumer “juice” brand that has both the national distribution of a CPG company and the national footprint of retail stores base.

 

As Howard Schultz said on the conference call, “we are leveraging the core capability and infrastructure of our company, and we've identified a major growth vehicle that, over time, will be highly complementary to our core business, and that is the experience that we create in our stores around beverage, the romance, the theater, and obviously the momentum and trend of health and wellness, we think we can build a major business.” 

 

I found it interesting that when asked about the potential for the new “national brand”, the comparison to Whole Foods came up and the response was as follows: “Other than Whole Foods, which is really not a health and wellness store but a grocery store selling high-quality products, we think we can bring this to life by really replicating the understanding we have about beverage capability, beverage recipes, and bringing the theater and romance, and ultimately the efficacy of juice, fruit and vegetables, to life in a unique way that positions us to build a health and wellness business.”

 

This suggests that this is not going to be a “juice bar” but a “juice/food bar”.   It will be interesting to see if they really do create something that's unique and proprietary in the size and scale of an existing Starbucks store.  The due diligence for the new concept included “traveling throughout the world, examining what others have tried to do around juice, health and wellness, tea, and things that are medicinal and have efficacy, and feel very strongly that we understand the beverage business perhaps better than anyone else who has been in small-box retail.”   

 

As management said on the call - “We've done a lot of research and found out that two-thirds of U.S. consumers want healthier options with wholesome ingredients.”  This is a strategy, from a marketing standpoint, that has served Chipotle well and, in time, Starbucks could adopt a similar angle.

 

SBUX – DRINKS WITH INTEGRITY - ev

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


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