SBUX: EXPENSIVE AND BUILT TO STAY THAT WAY

It’s amazing how far this company has come since the early days of 2009 when you couldn’t give the stock away.  Today, the investment case remains compelling.  The Starbucks turnaround has been nothing but spectacular and we continue to own the stock in the Hedgeye Virtual Portfolio.

 

Below, we have outlined some of the attributes of Starbucks that we believe will continue to fuel this company’s progress.

  1. A global retail footprint with 17,000 stores around the world; 60 million customer visits a week
  2. Frequency of customer visits that's perhaps unmatched in all of consumer
  3. Strong marketing and a social media presence that is innovative and authentic
  4. A rapidly growing and highly profitable consumer products business, which is allows the brand to grow “across multiple channels and multiple products globally.”

Below, we run through our thoughts on some of the more important topics raised by Troy Alstead, CFO of Starbucks, during a recent conference.

 

 

ELIMINATING THE MACRO RISK?

 

SBUX: “Prior to 2008, any bump up or down in consumer confidence was a bump up or down in that period of time to what happened in our stores, to our traffic, and to overall comp growth … we transformed the business over the last few years to focus on creating a wedge between those two lines, to give us some degree of insulation from what's happening in the overall macro environment to what happens in our stores. And, we've done that through things like our loyalty program, through elevating the customer experience in our stores back to the extremely high levels they had been historically and frankly to new levels.”

 

HEDGEYE: This is very interesting commentary about how Starbucks thinks about its business.  However, we would argue that the unemployment rate jumping 1-2% would slow traffic – particularly during the morning day part.  The following statement should raise eyebrows; “Today, the highest correlation to comp growth in our stores is our own satisfaction, as measured by our customers, in our stores.”  Paying attention to the macro indicators helps forecast that weather or operating environment and we believe that paying attention to the prevailing economic winds remains an important part of an investment thesis for Starbucks.

 

 

LOYALITY IS KEY

 

SBUX: “The loyalty program and our loyal customer set overall is a critical element of what we have built over time … it's given us a much more tangible way now to communicate with our customers, to give them an opportunity to engage with the brand, and to be rewarded for that. We have a very, very powerful digital presence, similar to our loyalty program itself, gives customers a chance to engage with us, to be a part of that dialog, and that's – no question – for us been an important part of our recovery in our business in the last two years and we think it gives us opportunities to engage more deeply with our customers in the years ahead.”

 

HEDGEYE: Technology has become a key driver of successful loyalty programs and a big driver of incremental traffic for the better-positioned restaurant companies.  With an expected one billion smart phone users, globally, by 2016, digital marketing is a must for every restaurant company and Starbucks is arguably one of the best companies, globally, at driving sales through new media.

 

 

LEVERAGING THE INFRACTURE

 

SBUX: “Our average unit volumes in our U.S. business stand at about $1.1 million today. That's the highest they've been in history and still more than half of that volume comes in the morning day part. Now, in recent years, we have slowly but surely begun to move the needle. That statistic I just threw out was 70% in the morning not all that long ago.” 

 

HEDGEYE: When companies in the restaurant industry focus on operating their existing assets more efficiently, it is amazing how innovative they can be.  Driving same-store sales over the next few years will be based primarily upon:

  1. Deepening offerings at lunch
  2. More relevant food options for the afternoon day part (Starbucks Petites Platform)
  3. Focusing on building sales of “attached-to-beverage” food items in the afternoon
  4. Raising the ceiling on capacity during busy morning period through technology (new POS system)
  5. Beverage innovation and general productivity.

 

 

THE EVOLUTION

 

"With our acquisition of Evolution Fresh, just very recently, this acquisition not only gives us an opportunity to significantly elevate and reinvent the $1.6-billion super-premium juice category, it also gives us a very significant next step into the overall $50-billion health and wellness category.

 

Consumers expect something different and differentiated when they come into Starbucks stores. We know that with our coffee beverages, our tea beverages, our food offerings and now with Evolution Fresh, we have the opportunity to elevate that within the Starbucks store as one pillar of introducing customers to this product. Standalone Evolution Fresh stores, concept stores which we'll open soon, and leveraging that further into the CPG channels."

 

HEDGEYE: Part of the growth profile of the company will be new unit growth.  International, especially China will be a big part of that growth.  Conceptually, we think the idea of expanding into the premium juice category could be successful for Starbucks but it will take a considerable amount of time before Evolution Fresh has any meaningful impact on the growth rate of the country.

 

 

SINGLE SERVE

 

SBUX: “Last week we announced our plans to round out our portfolio in the single-cup space by launching Verismo by Starbucks later this year.  Verismo fills out this offering to consumers by being a high-pressure offering – a high-pressure machine that allow – that provides that espresso opportunity in the single-cup space really for the first time for Starbucks and in a meaningful way.”

 

HEDGEYE: The battle between GMCR and SBUX is just beginning and we are betting on SBUX is going to be the ultimate winner.  Launching Starbucks K-Cups through the Keurig platform gave the company access to the largest installed base of single-cup brewers in the United States.  Starbucks continues to speak diplomatically about Green Mountain but we do not see that as a long-lasting partnership.

 

 

CPG

 

SBUX: “Our long-term targets for margins in the CPG segment are at 30% or somewhat higher than that, we believe, over time.  We had expected and targeted about 25% this year and that's about where we're trending at this point and that's driven by really two things.

 

Given visibility we have into coffee costs in the next year, which we now have a tailwind coming out of 2013 as well as lapping the investments we've made in the infrastructure in that division, we expect by the time we move into 2013 to move back into the upper 20%s and over the next two years to approach that 30% margin level again in CPG."

 

HEDGEYE: The CPG business is poised to show accelerating sales trends and stronger margins for the   next two years.  Coffee costs coming down sharply this year is very helpful for the CPG business; it was the hardest-hit during the recent spikes in the spot price of the commodity.

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


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