It's Tea Time…for the Coffee King!!

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

Starbucks recently announced its acquisition of Teavana for $620 million, which is Starbucks’ biggest acquisition to date. This provoked me to have a look at the company and its two peers Yum! Brands and McDonald's. While Starbucks is busy buying in the holiday season, Yum is finalizing its deal to sell its problematic Pizza Hut UK business. On the other hand, McDonald’s unsuccessful strategy of launching premium products has resulted in a change in its management for its US operations. McDonald's October month sales dropped 2% in the US market.

Starbucks has experienced a significantly higher new store growth rate, which is ~2x of Yum! and ~3x of McDonald’s in the current fiscal year.  Additionally, the company has the highest quarterly revenue growth of 11% against Yum’s 9% and McDonald’s -0.20%.

<table> <tbody> <tr> <td> <p><strong>Company Name</strong></p> </td> <td> <p><strong>Quarterly Revenue Growth (Y/Y)</strong></p> </td> <td> <p><strong>Gross Margin (Last 12 months)</strong></p> </td> </tr> <tr> <td> <p><strong>Starbucks Corporation</strong> <span class="ticker" data-id="205374">(NASDAQ: <a href="">SBUX</a>)</span></p> </td> <td> <p>11.00%</p> </td> <td> <p>56%</p> </td> </tr> <tr> <td> <p><strong>Yum! Brands, Inc.</strong> <span class="ticker" data-id="206222">(NYSE: <a href="">YUM</a>)</span></p> </td> <td> <p>9.00%</p> </td> <td> <p>27%</p> </td> </tr> <tr> <td> <p><strong>McDonald's Corp.</strong> <span class="ticker" data-id="204400">(NYSE: <a href="">MCD</a>)</span></p> </td> <td> <p>-0.20%</p> </td> <td> <p>39%</p> </td> </tr> </tbody> </table>

Source: Yahoo finance

Also, Starbucks has the industry leading gross margin ratio of 56% (vs. the industry average of 35%). Its strategically perfect acquisitions, on the other side, consolidate its position as a long term investment. Let’s have an overview of its growth drivers.

Teavana Acquisition:

The Teavana acquisition has been the most significant addition for Starbucks into its product portfolio. With Teavana’s mall presence of ~300 stores across the world, Starbucks will get direct access to these stores which are known for selling premium loose-leaf tea. Teavana has a store margin of ~30%, which makes it a perfect addition to the Starbucks portfolio. 

Starbucks has been focusing on ready to serve tea based beverages with its Tazo brand. This acquisition will provide it the platform for ready to serve beverages and at the same time, Teavana’s strong presence in loose-leaf tea business will provide it a totally different revenue stream.

One more factor which I feel would be advantageous for Starbucks is Teavana’s low focus on marketing activity. Starbucks will utilize its ability of driving sales through its loyalty programs and its social media proficiency in the tea category. Looking at the market (~$40 billion globally) and its comparatively small size, Teavana would provide Starbucks a huge opportunity for growth. Starbucks should remain committed with its Teavana expansion strategy and shall be taking the number of stores to ~500 by 2015.

Impressive Product Pipeline:

Starbucks has been focusing on launching new products, which are expected to provide a good growth avenue for the company. The company recently launched the Verismo system, which has been placed in 6400 retail locations. This product provides consumers an option of having Starbucks Caffe Lattes, Espresso and Coffee from a single machine. I think this product has immense potential as most consumers want a compact design without compromising on quality. Additionally, the company has various new products including Refreshers, Evolution Fresh juice and La Boulange bakery products.

Synergies from Past Acquisitions:

The company will continue to benefit from the synergies generated from its past acquisitions.

  1. Evolution Fresh:  Starbucks’s acquisition of Evolution Fresh in Nov 2011 provided Starbucks with a significant juice segment. Evolution products are now available in ~2200 stores. Additionally, the company is building a new production facility in California, which will help it further expand the placement of these products in its stores.
  2. Bay Bread:  Starbucks decided to acquire Bay Bread for $100 million in Jun 2012. This acquisition provided it with the opportunity of growing its food segment, which currently contributes ~20% of its total sales. The company is currently testing these products in a few stores, but it is expected that these products will be available in ~2500 stores by 2013.

Summing up, I think the company is well placed to grow from its acquisitions as well as from its product innovation strategy. There has been a secular shift in the consumer’s preference from soda based beverages to coffee and tea based beverages. The company looks in a perfect position to benefit from this trend, with significant coffee and tea based products in its portfolio. Additionally, the US market has been observing a tea consumption growth rate of ~2%, which is the second highest regional growth rate. This would provide the company with a massive opportunity for growth in the tea segment. Also, the favorable commodity prices have helped the company; which is further expected to improve in FY '13 & FY '14. Overall, I don’t anticipate any steep downside for this stock and would rate this stock a buy.


ShwetaDubey has no positions in the stocks mentioned above. The Motley Fool owns shares of McDonald's and Starbucks and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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