ONE MOVE TOO MANY?

If I had a rating to change on Starbucks I would downgrade it today.

 

After the market close yesterday, Starbucks announced that it has agreed to enter into a definitive agreement to purchase La Boulange Bakery for $100mm. Investments pertaining to the acquisition will dilute earnings by $0.02 per share in 2H12.  Further dilution is expected in FY13. 

 

The target of this $100mm acquisition, La Boulange Bakery, operates 19 retail locations in the Bay Area and sells its products to several upscale restaurants, hotels, and specialty grocery stores in the region.  The acquisition is aimed at improving the baked goods that Starbucks offers within its stores and represents, in our view, a significant gamble on the part of Howard Schultz and his team.

 

This move, along with the Evolution Fresh acquisition, is based on the Starbucks’ “multi channel strategy” of introducing the product through the national network of stores and then expanding the offering into the CPG channel once the brand gains traction.  This rationale behind this strategy seems to be based on the success of the Starbucks VIA product.  The risk, in the case of La Boulange products, is that the VIA strategy was successful as a Starbucks product and that that success will not transfer over to a non-Starbucks branded offering or that it will take longer than expected for the brand to resonate with consumers on a national level.  In terms of the schedule of rolling out the La Boulange offering, the company only said that the products will first show up in Starbucks’ San Francisco stores in 2013.  The offerings will initially focus on pastries and bread.

 

While we understand the appeal of the multi-channel strategy and can see the potential benefits, assuming that all of Starbucks’ initiatives are going to be successful is unlikely to be the right stance, if history is any guide.  Starbucks is an impressive organization and we have been behind the stock for over three years.  However, the company seems to have entered into an investment phase and that does change the outlook for the stock.   Entering into two significant initiatives (juice and food) at once increases the risk of setbacks for the stock; the consequences, for EPS, of any slowdown in the top line are larger going forward than they would have been over the past few years.

 

The Evolution Fresh strategy, while still unproven, could be more of an immediate-term positive given the limited capital investment required to get the product into the stores.  Applying the multi-channel strategy to food implies more risk to EPS over the next few years.  There is also the additional risk that, in quickly scaling the La Boulange offerings across the domestic store base, the company may compromise the integrity of what made La Boulange successful to date. 

 

Based on the conference call held this afternoon by management, our view is that the La Boulange strategy will likely require significant capital investment on the part of Starbucks.  More detail will emerge in the coming weeks but currently we believe that the near-term investment could be significant and the reward, while possibly substantial but not guaranteed, could take years to materialize.

 

Here are the primary takeaways from the call:

  • Food currently accounts for $1.5 billion in revenue at Starbucks’ domestic, company-owned locations and grew 14% year-over-year during the first two quarters of fiscal 2012.  Management expects this acquisition to help drive that growth over the longer term but few details were provided on the call.
  • Management will first introduce La Boulange products to Starbucks locations in the San Francisco area, beginning in 2013. The offerings will focus on pastries and bread at first.
  • The product will be prepared in company-owned facilities and management intends to build the La Boulange brand into a national presence.  Both of these will require significant capital investment.
  • Once the La Boulange branded products are being distributed to Starbucks stores nationally, management intends to leverage the brand through the CPG channel.

 

 

Howard Penney

Managing Director

 

 

Rory Green

Analyst

 

 

 


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