Editor's Choice

A Great, Extraordinary, Endeavoring Company

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I’m not afraid to let people know I love Starbucks (NASDAQ: SBUX). The company transforms coffee from a commodity to an experience. Any one of its 19,000-plus stores provide the perfect setting for working, studying, reading, or (my favorite) picking up blondes. Oh, and baristas will serve you coffee too.

In its latest earnings report, Starbucks roasted all analysts’ estimates, sending the stock up more than 6%. While the numbers were fantastic, it would be unreasonable to think Starbucks should, or even could, repeat with similar results in the near future. Instead, I love Starbucks because, as CEO Howard Schultz pointed out on the conference call, management is “building a great, extraordinary, endeavoring company.”

A quick look at the earnings

I’d be remiss if I didn’t at least mention some specifics from Starbucks’ third quarter earnings release.

Most notably, the company reported an unfathomable 9% comparable store sales growth in the “saturated” U.S. market. A small price increase (about 10 cents) on select drinks certainly helped, but the 7% increase in traffic was the real driving factor behind this phenomenal number. For comparison, Panera (NASDAQ: PNRA) increased traffic by a paltry 0.9% last quarter.

On top of that, Starbucks reported a 28% increase in earnings per share to $0.55 and a 13% increase in revenue to $3.7 billion, both records. Earnings growth was fueled by a 150 basis point expansion in operating margin to 16.4%.

Any way you look at it, Starbucks delivered one piping hot quarter.

Building a great, extraordinary, endeavoring company

These numbers are the result of strong management and an excellent growth strategy that includes continually increasing its global footprint, particularly now in Asia, a robust and growing pipeline of innovation, and efficient operations. As the company executes on these fronts, great numbers, like what we saw in its third quarter, will certainly follow.

Asia

Starbucks posted fantastic results in Asia last quarter, where same store sales grew 9% year-over-year. This was with most of its Asian operations in a country, China, facing an economic downturn where most consumers were thought unable to afford $4-$5 coffees. Yet, the expanding middle class fueled further growth at the nearly 600 locations throughout the country operating a year or more.

But Starbucks has a lot of room to grow in the region. By 2015, the company plans to have over 1500 stores in China, making the country its second largest market (behind the U.S.). Additionally, it plans to open 100 new stores in Malaysia over the next four years, adding to the 147 current locations. Currently, the company operates over 700 stores in Southeast Asia.

Most recently, the company entered Vietnam, which unlike most other Asian countries already has a thriving coffee culture inherited from French colonists. With a young population enthralled by brand names, Starbucks could thrive in the country.

McDonald’s (NYSE: MCD) sees the same opportunity Starbucks does in the country, and plans to open its first restaurant in Vietnam in early 2014. McDonald’s faces slow growth in Asia, with same store sales flat in the region last quarter (partly due to an avian flu outbreak in China). Expanding into Vietnam won’t solve all of its problems, considering the relatively small size of the country, but it certainly shows management has faith in the region to pick up again.

One of Starbucks’ biggest endeavors is in India, where the majority of consumers still prefer tea over coffee. But remember, as I mentioned earlier, Starbucks doesn’t sell coffee, it sells an experience. Besides, Starbucks’ Chai Latte is, aside from being delicious, the morning drink of choice for many Indians. I’m confident Starbucks can turn this emerging economy into another strong market for its products, much like it has in China.

Pipeline

Starbucks has three big name initiatives in the pipeline that will further fuel growth going forward: La Boulange, Teavana, and Evolution Fresh. In the coming years, Starbucks will be able to leverage these brands to fuel further growth in same store sales and consumer goods sales.

Earlier this year, Starbucks upgraded its traditional pastry offerings to La Boulange branded products in 1,000 stores. Schultz reported on the conference call that La Boulange baked goods have seen tremendous uptake, but did not impact the same store numbers due to the limited roll out. The company plans to roll out La Boulange to another 1500 stores by September.

As more stores get the baked goods upgrade, same store sales ought to grow as both ticket size and traffic increases. With higher quality food items, Starbucks may be able to steal traffic away from breakfast and lunchtime competitors like Panera.

Last year, Starbucks purchased Teavana to better capitalize on the $40 billion tea market. The company plans to open its first street-front Teavana location in New York this fall and rebrand its Tazo store in Seattle. The company plans to do the same for premium tea as it did for coffee, as it starts to sell more tea drinks at the existing 350 Teavana locations. Additionally, the company plans to incorporate Teavana items on its Starbucks menu, which will increase its brand awareness.

Finally, the Evolution Fresh brand is perhaps most exciting because of what it could do for Starbucks in the grocery aisle. The company recently reduced its price on packaged coffee in order to compete with fierce competition. Yet, its K-Cup business continues to boom with a new 5-year contract with Green Mountain Coffee Roasters, and its Evolution Fresh brand continues to expand its product selection.

Most recently, Starbucks made a deal with Danone to create a line of Greek yogurt and yogurt parfaits available in both Starbucks locations and grocery stores. New state-of-the-art juiceries will allow Starbucks to expand the reach of Evolution Fresh, placing it in more grocery stores. Already with 6% of the premium juice market, Starbucks stands to gain significant market share as it ramps up operations in the segment.

Margin expansion

Starbucks is increasing traffic and ticket sizes, meaning each location and each man hour is producing more profit for the company. Innovations such as its mobile payment system help facilitate the flow of traffic.

Meanwhile, Panera suffers from tremendous in-store operational inefficiencies. Its traffic growth is slow despite large crowds showing up at lunchtime. As fellow Fool Demitrios Kalogeropoulos noted “the customer traffic was there, but service just wasn't quick enough to satisfy it.” Furthermore, the company suffers from diminishing sales at breakfast, which Starbucks and its new La Boulange baked goods will happily welcome into its stores.

Perhaps Panera ought to take a page or two out of Starbucks’ book in order to get its restaurants operating more efficiently. While it did post a 60 basis point increase in operating margin last quarter, it guided for flat to negative operating margin growth in the second half of the year.

Starbucks, on the other hand, is operating extremely well, posting an operating margin of 16.4% last quarter. Part of the 150 basis point expansion was due to improved sales leverage (more sales, same resources), the other part was due to the falling price of coffee (as a commodity). I expect that trend to continue for some time, and Starbucks is poised, more so than its competitors, to capitalize on that trend with 75% of its sales coming from beverages.

Conclusion

Yes, Starbucks just had a blowout quarter - a quarter that makes me want to proclaim my love for the company from a mountain top. Lacking a mountain top, I’ve chosen this outlet. But it’s not the numbers that make me so attracted to the company, it’s the reason behind those numbers - the “great, extraordinary, endeavoring company” that has the potential to post consistently great numbers. With great management and a strong growth plan, I think investors can still buy into Starbucks, even at an all-time high.

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Adam Levy owns shares of Starbucks. The Motley Fool recommends McDonald's, Panera Bread, and Starbucks. The Motley Fool owns shares of McDonald's, Panera Bread, and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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