Starbucks' Overseas Operations Percolating

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In 2008 Starbucks (NASDAQ: SBUX) operations in the United States were not in good shape, forcing its founder Howard Schultz to return to the company and revitalize the business. Mr. Schultz was largely successful in his effort, resulting in roughly a sixfold gain in the stock since then. 

But this focus on the U.S. came at the cost of ignoring its stores in the other regions of the world. Its European stores in Starbucks' first fiscal quarter accounted for less than a tenth of total revenues. 

So now Starbucks is launching the same sort of effort towards its stores in Europe. Sales and profits for stores in this region continue to grow but their performance badly lags that of the company overall. For instance, operating margins at these stores are only 6.5%, well below the Americas' region operating margin of 22%. 

The company has started a very aggressive marketing campaign which includes a promotion for free drinks. Starbucks is also rolling out a number of new offerings on its menu which cater to local tastes such as a lighter espresso in France. This campaign is sure to crimp operating margins over the short-term. The hope is that over the longer term, these changes will turn the tables on the European competition which has had little to fear from Starbucks since 2008. 

However, Starbucks is not struggling in all of its overseas markets. Its Asian operations are percolating, with operating margins more than double that of Europe, on half the revenues. The star market for Starbucks in Asia is China, where it operates more than 500 stores. Its chairman Howard Schultz called the Chinese market “the most profitable in the world”. 

And with good reason. Operating margins in China came in at 34.6% in the first quarter, more than 5 times that of Europe. Its Chinese stores typically generate between one-half and two-thirds the sales of U.S. stores but are more profitable than those in the United States where operating margins were 21.8% in the first quarter. That is thanks no doubt to cheaper labor, rent and utilities. 

Starbucks certainly has plenty of room for growth in the Asian region. Revenues from Asia accounted for a mere 5% of total sales (the Americas accounts for 75% of total sales) although sales in the region did rise 38% in the latest quarter from the same year-ago period. 

The company has plans for aggressive expansion in the region. Foremost among the target markets will be China where there will be a rapid roll-out of stores. Mr. Schultz said, “We will open thousands of stores in China over the next few years.” 

Starbucks also has its sights set on Asia's other emerging economic giant, India. It recently announced an $80 million 50/50 joint venture with Tata Global Beverages to bring its coffees to India. India is definitely a growth market. Its food services retail market generated about $8.2 billion last year and is forecast to grow more than 10% annually over the next five years by retail market consultancy, Technopak. 

The goal of its Indian venture (which plans to have as many 50 stores open by year end) is to eventually equal the success the company has enjoyed in China. But it will face stiff competition from domestic rivals such as Cafe Coffee Day which is backed by U.S. private equity firm KKR. Not to mention all the small, local tea stalls that sell the Indian favorite, chai – a sweet, milky tea. 

It is interesting to note that Starbaucks' biggest rival – Dunkin' Donuts, part of Dunkin' Brands (NASDAQ: DNKN) – also recently announced its entry into the Indian market with a local partner, Jubilant FoodWorks. Jubilant is the local partner for Domino's Pizza in India.  

Dunkin' will open its first store in June, several months ahead of the planned opening of the first Starbucks store. The company, however, will not focus on the coffee part of its business. Instead, it will focus on food and brand itself as an all-day eatery. Dunkin' believes it will face less competition in this niche of the Indian market. 

The goal of both Starbucks and Dunkin' is to reduce the revenue dominance of the U.S. market and have rapidly growing sales overseas, particularly from the large emerging economies of China, India and others. Shareholders surely hope they succeed.


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