Starbucks Has a Bun in the Oven (But You Can't Eat it Until 2013)
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What has Happened?
Leave it up to Starbucks (NASDAQ: SBUX) to announce another game-changing initiative to supplement its core brewed coffee operation. Weeks after the corporation’s annual shareholders meeting that tied together the other ventures it has announced in 2012 – Verismo single serve brewing machine, stand-alone Evolution Fresh outlets, and the Refreshers energy drink line – the coffee king has released information on the growth of its food offerings through the acquisition of San Francisco-based Bay Bread.
The $100 million acquisition, which will not only give Starbucks access to Bay Bread’s 19 La Boulange-branded bakeries but also its thriving wholesale unit, was received with mixed reviews by the market. After closing the day up 3.4% at $53.90/share, Starbucks trended down by as much as 3% in after hours trading.
How Will it Go Down?
Through the acquisition of the bakery chain Starbucks will be able to better vertically integrate its growing food product line, which has traditionally been sourced through third party vendors. The San Francisco-based Starbucks locations are planned to be the first outlets with the new bread and pastry products in 2013, and the corporation has intentions of penetrating the majority of its domestic base of nearly 11,000 stores by the end of next year.
Starbucks management has announced a multi-pronged growth platform with the acquisition:
- La Boulange Growth: Bay Bread runs a commissary model whereby one central kitchen supplies a handful of retail locations. All of the bakery’s retail outlets are in the northern portion of California in San Francisco and the surrounding fringe, but the corporation also intends to enter the Los Angeles market soon by using the central kitchen (used for wholesale operations) in the city. Although the La Boulange cafes will add relatively little to Starbuck’s top line, the corporation has plans to continue growing the thriving Californian chain.
- Wholesale Growth: Bay Bread’s revenue is based on an almost even split between retail and wholesale operations. The wholesale portion of the business also has serious potential for growth, starting with the California market. Bay Bread not only supplies local restaurants and hotels with fresh bread and pastries, but also supplies private label products to popular and swiftly growing grocery clients including Whole Foods and Trader Joe’s.
- Starbucks Locations: The primary reason for the acquisition is (obviously) to lever Bay Bread’s winning recipes through Starbucks locations to deliver fresher food offerings to domestic customers. Starbucks will be gaining some production capacity through the purchase, but to supply the huge base of United States stores it will also need to leverage other outside suppliers to (many of which it works with today) to make product. Starbucks management released little information about future capital spending requirements, but it does not expect food capex to rise substantially from today’s levels.
- Starbucks CPG: One of the fastest growing segments of Starbucks is its consumer products group, which pushes products through other channels to reach consumers outside of physical Starbucks stores. Similar to the strategy behind the success of the Starbucks Via product line, the corporation mentioned that it does have intentions of eventually pushing Starbucks-branded bakery items through grocery and warehouse clubs via the CPG channel.
Why Does it Matter?
At a $100 million purchase price (less than ½ of a percent of Starbucks’ market cap), Bay Bread initially appears to have little potential to make a huge difference to Starbucks’ operations. Besides the bakery’s own growth story – revenues of $60-$90 million in 2011, 10% top line growth per year since franchise opened in 1995 – the acquisition will have a meaningful impact on Starbucks’ all-important food revenues.
As the success of Panera (NASDAQ: PNRA), with revenues growing at a 25% CAGR over the past decade, shows, there is a huge opportunity on the upscale end of the quick serve restaurant market. Although Starbucks management did not explicitly mention the attack of Panera being the driver behind the Bay Bread acquisition, the writing is on the wall.
Starbucks’ own food revenues have been a huge growth driver for the corporation, as they have expanded twice as fast as core coffee revenues over the past five years -- 10.2% CAGR vs. 4.7% CAGR. The corporation, however, is still far from where it wants to be on the food frontier. Only one in three customers actually purchase food items, and the corporation attributes much of the lack of penetration to food quality and freshness. The post-acquisition Starbucks model will be much more akin to that of Panera, which makes its own breads and pastries fresh each day.
Even though Panera shares did trade down more than 1.5% after hours following the acquisition announcement, it is not the only player that should be worried about defending its piece of the pie. For Starbucks, the Bay Bread acquisition also means more revenues from other day parts. Quick serve restaurant alternatives including Panera, McDonald’s (NYSE: MCD) and Wendy’s (NASDAQ: WEN), for instance, have experienced meaningful growth in off-peak hours through the introduction of intriguing snack items including wraps, smoothies, and salads.
Starbucks has made huge progress in gaining business in these other day-parts, but it is still not the primary choice for most consumers for afternoon cravings. Nearly one-half of company operated store revenues still come from the morning shift (5am – 11am).
Although the market received the acquisition news with mixed reviews – the after hours drop was most likely due to the two cent per share dilution effect that was announced – there is reason to believe that Bay Bread will grant Starbucks a legitimate launching pad for future growth in the food category. Likewise, despite the recent uncertainty surrounding Starbucks shares (they have pulled back 15% from mid-April highs), the new ventures announced thus far in 2012 show that Starbucks is one of the few companies in the food/beverage segment with a cohesive growth strategy. Starbucks not only has some very intriguing products on the horizon, but through 17,000+ stores worldwide and a thriving CPG channel it also has a more effective way than the competition to push products to the masses. Investors should be ready for significant Starbucks growth over the mid-term.
gibbstom13 has no positions in the stocks mentioned above. The Motley Fool owns shares of Panera Bread, Starbucks, and Whole Foods Market. Motley Fool newsletter services recommend McDonald's, Panera Bread, Starbucks, and Whole Foods Market. 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.