Will Starbucks Continue to Heat Up?

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

The ongoing rally of shares of Starbucks (NASDAQ: SBUX) hasn’t slowed down, and its latest earnings report kept investors happy. Will this company’s stock keep rising? Is the company facing perils that could curb its growth? 

Revenue keeps growing

In the third quarter of fiscal 2013, revenue of Starbucks rose more than 13% (year-over-year). In comparison, other leading brands, such as Dunkin' Brands Group (NASDAQ: DNKN), haven’t shown such a sharp rise in revenue. Dunkin' Brands’ net sales increased only 5.9%. For Starbucks, most of the growth in revenue was in China/Pacific region. The company’s net revenue jumped 29% during the quarter. This region’s revenue accounts for only 6% of Starbucks' total revenue.

But, at the current pace, the China/Pacific region should account for roughly 10% of its revenue by the end of the year. Nonetheless, the latest developments in China might lead to an economic slowdown in this country, which may curb down the high growth rate of Starbucks in China. Furthermore, the high volatility in the currencies markets could also slash some of its revenue.  

Most of the growth of Dunkin' Brands’ revenue was related to its Baskin-Robbins International segment that grew 16% (year-over-year). But this jump in revenue was partly attributed to the company’s change in its Bertico litigation reserve from last year, and the income from selling 80% of its Baskin-Robbins Australia business. Therefore, the company’s revenue, after excluding these one time events, didn’t increase much. 

Profit margins

Even though Starbucks augmented its revenue, the company’s profit margin expanded. Its profitability rose to 16.4% in the third quarter of fiscal year 2013. Most of the growth in profit margin was due to the rise in its profitability in China/Asia Pacific and Americas segments. The EMEA segment continues to have very low profit margin of only 3.2%. The sharp rise in Starbucks’ China/Asia Pacific segment is likely to further augment its profit margin. On the other hand, the slow growth in the EMEA segment might benefit the company as it will lower its exposure to these regions that have very low profitability. 

Starbucks wasn’t the only company in this industry that experienced a rise in profitability: Dunkin' Brands also pulled up its profit margin to 42.1% -- an increase of more than 15.3 percentage points. But this jump in profitability is a bit misleading, and is mostly related to the company’s recognized profits from selling its Baskin-Robbins Australia business. The company’s gross profitability remained nearly unchanged at around 80%. This suggests Dunkin' Brands profitability hasn’t increased due to its core operations.  

Starbucks keeps expanding its brand

The company doesn’t only expand its reach to other countries such as China, it also expanding its brand with its collaborations with other leading companies such as Teavana Holdings. Starbucks purchased Teavana at the end of 2012, which makes Teavana a full subsidiary of Starbucks. It paid $620 million for the company. This acquisition helped Starbucks expand its brand beyond coffee and target the tea market as well. Starbucks’ CFO, in an interview, also expressed his confidence in incorporating the Teavana brand into Starbucks.

The company also expanded its agreement with Green Mountain Coffee Roasters (NASDAQ: GMCR) vis-à-vis the manufacturing, marketing, distribution, and sale of Starbucks and K-Cups worldwide. This partnership, which started back in March 2011, has benefited both companies in expanding each other’s brand and revenues. Starbucks has successfully sold more than 850 million Starbucks coffee K-Cup packs in two years. This partnership has helped pull up Green Mountain’s stock that has soared by approximately 84% (year-to-date).

The company’s revenue also rose 13.5% in the first quarter of 2013 (year-over-year) and its profitability increased by 4.2 percentage points to 21.1%. So, both companies have benefited from this partnership. By expanding this deal, both companies are likely to augment not only their revenue, but also their profit margins.  

Coffee prices

One of Starbucks’ main inputs is (no surprise) coffee. Even though the company hedges against the fluctuations of coffee prices in the near future, the changes in the price of coffee could affect the company’s profit margin in next year before the company secures its next coffee future contracts. Looking forward, Goldman Sachs analysts suspect the price of Arabia coffee will reach within 12 months $1.30 a pound, which is not far from the current price of Arabia coffee. The expected high production compared to the demand is likely to curb coffee prices from rising. If this projection comes to fruition, it could slightly expand Starbucks’ profit margin, or at least it won’t diminish it.  

Takeaway

I think that Starbucks is on the right track by expanding its brand with acquisitions, partnerships, and by reaching new markets in other countries such as China. The current low coffee prices and the high profitability in China branches could also further widen Starbucks’ profitability in the near future. But, the potential economic slowdown in China could curb the growth rate of Starbucks.  

For further reading: Why Coffee Prices aren’t affecting Starbucks?

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Lior Cohen has no position in any stocks mentioned. The Motley Fool recommends Green Mountain Coffee Roasters and Starbucks. The Motley Fool owns shares of 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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