The Green Mountain Coffee Roaster Killer

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

I’m guilty. I grumble and complain when I fill up my vehicle with gas that costs $3.75 a gallon. I’m still grumbling when I roll through the drive through and order a $4.50 mocha. Despite my complaining about costs, that's the moment when my mood starts to improve for the morning. And I’m far from alone in this morning routine.

What drives us towards our Starbucks (NASDAQ: SBUX) routine? I think the answer can be found 4 years ago when Howard Schultz outlined a 5 point strategy aimed to make Starbucks the most successful coffee house the world has ever seen. Below I'll analyze 3 of the points he emphasized.

Customer Experience
The first goal Shultz put forth was to improve U.S business by focusing on customer experience in stores. Local coffee shops do a great job of providing especially tranquil and warm atmospheres. With this strategy, stores were encouraged to add their own local personality and influence to make their stores more welcoming. Shultz believed getting away from a franchised look was key to future success. I can count on Starbucks employees being excellent at their job and very friendly. I can count on a cozy place to enjoy my coffee and even work temporarily. Sounds easy -- wouldn't competitors simply copy this environment?

Copying Starbucks is easier said than done. It could have been bad luck with my awful experiences at Dunkin' Brands (NASDAQ: DNKN) but I won’t be returning anytime soon. Dunkin’s coffee doesn’t match the quality of coffee, the employees weren’t real friendly and the atmosphere wasn’t localized or filled with personality.

McDonalds (NYSE: MCD) is a powerhouse of a company, don’t get me wrong. Their past success and brand speak for themselves. They even make pretty decent coffee to imitate Starbucks’ specialty coffee. All that said, I don’t believe they represent a true threat to the Starbucks market because, like Dunkin Donuts, the atmosphere and in-store experience will never compete.

The Starbucks experience is great in every aspect and competitors have had trouble replicating that success. What about out of store products?

Enter Starbucks Verismo
I’ve already made space on my office desk dedicated to one thing: Starbucks Verismo. Single cup coffee is the fastest growing segment of the coffee market and Starbucks is coming in hot. This is bad news for Green Mountain Coffee Roasters (NASDAQ: GMCR). Since the Verismo announcement GMCR's share price has dropped roughly 25%.

All joking aside, GMCR is the market leader in single cup coffee for a reason. Starbucks will have their work cut out for them, but the Starbucks brand will no doubt make an impact and take market share. Kraft Foods (NASDAQ: KRFT) is also introducing K-Cups through the Maxwell House brand, and that will ramp up competition in the single brew pods. Because the GMCR patent ran out recently, other brands no longer have to license K-cups or pay royalties. I believe this will hurt GMCR’s market share and tilt it in favor of the major brand names in coffee.

Reviews for the quality of coffee from Verismo have been very positive thus far. Starbucks has the market covered, in store and out. The Verismo will make an impact and Howard expects their single cup coffee line to be worth a billion dollars in the future. What else did Howard Shultz outline in his strategy?

Howard wanted to slow the pace of U.S. expansion and close underperforming stores to optimize operations. He pumped the brakes by closing nearly 1,000 stores worldwide, 800 in the U.S. This resulted in roughly 19,000 store positions and an additional 1,700 corporate positions being eliminated. That’s pretty rough stuff. Has it paid off? Let’s view some financials from 2008 to present.

<table> <tbody> <tr> <td> <p> </p> </td> <td colspan="3"> <p>Starbucks ( $ in millions)</p> </td> <td> <p> </p> </td> </tr> <tr> <td> <p> </p> </td> <td> <p>2011</p> </td> <td> <p>2010</p> </td> <td> <p>2009</p> </td> <td> <p>2008</p> </td> </tr> <tr> <td> <p>Revenue</p> </td> <td> <p>11,700</p> </td> <td> <p>10,707</p> </td> <td> <p>9,775</p> </td> <td> <p>10,383</p> </td> </tr> <tr> <td> <p>Operating Income</p> </td> <td> <p>2,075</p> </td> <td> <p>1,865</p> </td> <td> <p>1,331</p> </td> <td> <p>1,279</p> </td> </tr> <tr> <td> <p>Net Income</p> </td> <td> <p>1,246</p> </td> <td> <p>946</p> </td> <td> <p>391</p> </td> <td> <p>316</p> </td> </tr> <tr> <td> <p>Cash Flow</p> </td> <td> <p>1,796</p> </td> <td> <p>1,486</p> </td> <td> <p>926</p> </td> <td> <p>865</p> </td> </tr> </tbody> </table>

Everything above has improved nicely since 2008, including a quadruple in Net Income and doubled Cash Flow.

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>Starbucks ( % )</p> </td> <td> <p> </p> </td> <td> <p> </p> </td> <td> <p> </p> </td> </tr> <tr> <td> <p> </p> </td> <td> <p>2,011</p> </td> <td> <p>2010</p> </td> <td> <p>2009</p> </td> <td> <p>2008</p> </td> </tr> <tr> <td> <p>% Long Term Debt of Capitalization</p> </td> <td> <p>11.1</p> </td> <td> <p>13</p> </td> <td> <p>15.3</p> </td> <td> <p>18</p> </td> </tr> <tr> <td> <p>Net Margin</p> </td> <td> <p>10.6</p> </td> <td> <p>8.8</p> </td> <td> <p>4</p> </td> <td> <p>3</p> </td> </tr> <tr> <td> <p>%Return on Assets</p> </td> <td> <p>18.1</p> </td> <td> <p>15.8</p> </td> <td> <p>7</p> </td> <td> <p>5.7</p> </td> </tr> <tr> <td> <p>%Return on Equity</p> </td> <td> <p>30.9</p> </td> <td> <p>28.1</p> </td> <td> <p>14.1</p> </td> <td> <p>13.2</p> </td> </tr> </tbody> </table>

Again, everything above has improved nicely since 2008. Margin and RoA has tripled while RoE has more than doubled. Long term debt to capitalization has dropped nearly 40%. In the fourth quarter of 2011, Starbucks reported that comparable store sales rose 9% year over year on 6% increase in foot traffic with an increase in 3% average ticket ring. It’s safe to say the strategy to optimize the operations at Starbucks has paid off.

I’ve covered 2 of his 5 points,and  thus far both have proved to be home runs. Next up?

First Seattle, then the World!
Next on the agenda is for Starbucks to conquer the world. Schultz called on the company to accelerate expansion outside the U.S. and drive profit margins higher internationally. You can find a Starbucks nearly anywhere, but Schultz wants the company to focus on certain areas.

China is a target because its single cup market grew 50% last year, and as the wealthy middle class grows that number will continue to rise. Europe, even amidst all its chaos, still consumes insanely more coffee per capita than China, making it a viable target for expansion. Schultz also suggested that Latin America could be lucrative. There are already developed plans for stores in Mexico and Argentina.

Bottom Line
Howard Shultz gets it. He’s a CEO with a vision. He’s a CEO with a strategy that didn’t focus on the next quarter. As a long term investor, that’s what I like to see in management.

Look for the Verismo to sell well during the holiday season, and if the cost of coffee drops as expected, Starbucks could be ready for a rebound in stock price. Starbucks has built a global brand and has room left to grow. Since 2008 they’ve re-energized the brand and built an emotional connection with their consumers. They’ve managed to do this through in store experience, excellent customer service and quality coffee!

All this success has come without any money being spent on advertising. You can tell me the stock price is overvalued, which is arguable. I'd argue that this is an extremely successful company and will be well into the future. Successful companies like Starbucks is exactly where investment dollars belong.

Know What You Own

With Green Mountain as cheap as it's ever been, many investors are wondering whether this is the end of the former market darling, or the perfect entry point for an enormous rebound. You can find a recommendation for how to approach investing in the company in The Motley Fool’s new premium research report. In it you'll find everything you need to know about Green Mountain, including whether it's a buy at today's prices. Click here for instant access.

dmiller5350 has no positions in the stocks mentioned above. The Motley Fool owns shares of McDonald's and Starbucks and has the following options: long DEC 2012 $16.00 puts on Green Mountain Coffee Roasters, short DEC 2012 $21.00 calls on Green Mountain Coffee Roasters, and short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Green Mountain Coffee Roasters, McDonald's, 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.If you have questions about this post or the Fool’s blog network, click here for information.

blog comments powered by Disqus