Stock story: Starbucks

Feel like a coffee? At a Starbucks café in the US you could try the Eggnog Latte or the Gingerbread Latte or one of the Frappuccino® cold coffees. If you want a hot chocolate, the choices include the new Toffee Almondmilk or the Snickerdoodle. Prefer a tea? Perhaps you could try the Teavana® Apple Joyful Medley option or the Emperor’s Cloud and Mist® Green selection. You can instead opt for a Fizzio™ ‘handcrafted’ soda. You can grab a bite to eat as well. Whatever you select, your choice is personalised, delivered with a smile in a café with a localised décor that styles itself as a ‘neighbourhood gathering place’, somewhere to escape home and work. Such is the formula behind the world’s largest chain of coffee shops.

From a store in Pike Place Market that overlooks Seattle’s waterfront, Starbucks has ballooned into a chain that serves about 90 million customers a week across its 27,339 company-owned and licensed outlets in 75 countries. The company, named after the first mate on the whaler Pequod in Herman Melville’s novel Moby Dick, earned revenue of US$22.4 billion in fiscal 2017, up 7% from a year earlier.

The key to the Starbucks juggernaut is the company’s success in making people want to come back for the beverages and food in its cafés. To encourage customers to return, Starbucks runs stylish cafés in key locations where people are free to hang around. As eclectic music plays, baristas greet regulars by name and customise their drinks from the vast number of combinations available worldwide. The company is making mobile order and pay widely available to speed up service and it operates the Starbucks Rewards™ loyalty program to give people a financial incentive to order again.

The habitual nature of coffee, Starbucks’s loyal customers, their appreciation for Starbuck’s as a destination in itself, which limits disruption risk, the company’s aggressive focus on expanding its chain, especially in China, its ability to generate healthy same-store-sales growth, a renewed focus on controlling costs, steady product innovation and the prized brand represented by the twin-tailed-siren logo make Starbucks a compelling company from an investor’s point of view.

Starbucks has its challenges including that it is part of a competitive industry in which a number of up-starts and established companies are trying to replicate Starbucks’

success. The pace of growth slipped in fiscal 2017 when same-store-sales growth only rose 3% compared with 5% in fiscal 2016. However, even allowing for the slower growth rate over the past 12 months, sales growth averaged 10% p.a. over the past four fiscal years while earnings-per-share growth averaged 17% p.a. so the company’s operating history is strong and is likely to stay that way.

Growth focus

While Starbucks traces its history to 1971, the pivotal moment occurred 10 years later when Howard Schultz walked into a Starbucks store and tried a cup of Sumatra. Impressed by the operation, Schultz joined a year later to become director of retail operations and marketing. Schultz’s vision for Starbucks emerged from a trip to Italy in 1983 when he saw how influential cafés were in Italian community life. In 1984, he convinced the Starbucks founders to mimic the coffeehouse concept and the first Starbucks Caffè Latte was served in Seattle. After leaving Starbucks in 1985 to start an Italian-style coffeehouse named Il Giornale, Schultz returned in 1987 when Il Giornale purchased Starbucks. Total stores at the time numbered 17.

Schultz became chief executive and chair of the revamped Starbucks and infused the chain’s cafés with the feel of the Italian coffee bars. While Schultz stepped down as CEO in April of 2017, he remains chairman and owns about 3% of the company that was listed in 1992 when Starbucks had 165 stores.

The company’s café chain, which expanded by 2,254 outlets in fiscal 2017, brings in about 90% of the company’s revenue while consumer-packaged goods and ‘foodservice’ (wholesale sales of whole bean and ground coffee etc.) drive the remainder. Away from its cafés, Starbucks’s ambitions include gaining a share of the ‘at-home coffee’ market by selling coffee machines and associated pods, now available from other outlets as well as Starbucks stores. Other revenue comes from ready-to-drink beverages such as Frappuccino® and Starbucks Doubleshot® sold worldwide through channels such as grocery and convenience stores.

Starbucks remains focused on growth, especially in the US and China, and on expanding its profit margins. The company aims to deliver high single-digit revenue growth each year over the long term by driving more volume through existing stores and expanding the global footprint. Its target for earnings-per-share growth is 12% per annum, or better.

Starbucks has robust plans for China, which is its fastest-growing market. It achieved same-store sales of 7% in fiscal 2017 compared with 3% overall and in the US. In fiscal 2018, the company plans to open nearly 600 outlets in China, and recently bought out the partner of its Chinese joint venture that operates around 1,300 stores. When the transaction is completed, the company will control about 2,900 locations in China. As with every Starbucks café, each will offer personalised choice with a smile in a café with localised décor that doubles as a neighbourhood gathering place.