Tea And Technology Should Fuel Q2 Starbucks Gains

Starbucks London 2012 2
Man carrying an umbrella walks in the rain past a Starbucks coffee shop in London. Reuters

Starbucks Corporation (NASDAQ:SBUX) has been working to maintain global dominance as a coffee retailer by separating itself from rivals through the introduction of new food items and a digital strategy unique to the industry. That strategy is expected to pay off handsomely when the Seattle café giant posts quarterly results that leave the competition far behind.

The company has more than 2,000 locations in 60 countries, with major store growth in the China-Asia-Pacific region, where it plans to build most of the planned 1,500 new stores by 2015. But the most important thing isn’t how many stores the company has, it’s what they’re serving -- and especially how.  

One of the ways Starbucks has stood out among other coffee retailers is through online and mobile projects, which CEO Howa­rd Schultz has long been advocating.

When the Seattle-based café giant will report on Thursday after market close, analysts polled by Thomson Reuters expect profits in the fiscal second quarter of $425.34 million, up 8.9 percent from the same quarter last year. Earnings per share during the January-March period is expected to jump to 56 cents, up from 51 cents a year earlier, as revenue jumps 11.1 percent to hit $3.95 billion.

“Starbucks is also much more than retail expansion story. At a time when most restaurant and retailers are struggling to stimulate transaction growth, Starbucks' recent transaction gains are impressive and underpin the global strength of its brand,” Barclays analysts said in a note to clients earlier this month.

The 2013 holiday season was a shock for many brick-and-mortar retailers who watched foot traffic give way to online shopping, and physical gifts get replaced with cards.

“Starbucks was prepared for both of these shifts, having invested over many years in the creation and development of proprietary world-class digital and mobile payment and card technology and expertise,” Schultz said on the first-quarter earnings all, where he also noted the nearly 10 million customers using the mobile payment app, which allows customers to pay using their phones, track loyalty points and even tip baristas.

In North America, 14 percent of Starbucks transactions were made via mobile, and more than $612 million worth of loyalty cards were activated over the holiday period alone -- benefits that should carry over in the next few months.

“We think post-holiday gift card redemption could potentially offset any weather-related choppiness,” reads a note from analysts at Jefferies regarding the second quarter.

Nevertheless, they still predicted earnings per share at 55 cents, just under consensus, citing deteriorating economic trends, “regional economic woes” affecting European business and a possible slowdown in the single-serve market.

Jefferies' analysts wrote that it hasn’t been a friendly quarter for most restaurants, but “companies with real menu innovation, attractive value propositions, strong brand loyalty and more effective marketing/digital strategies” should be able to withstand it, citing Starbucks as one of them.

Starbucks has also added new products to stores to bring in new customers, with plans to increase the average ticket price, or how much each customer spends while there.

Barclays analysts forecast 11 percent top-line growth driven by 5 percent growth in the Americas and 5 percent growth in China/Asia-Pacific based “largely on traffic gains as well as a modest increase in the average transaction size due to new in-store food and packaged good offerings,” according to a Jan. 29 note.

Same-store sales grew by 7 percent in both 2012 and 2013, but last year’s increase had a higher proportion of ticket price growth than just traffic, meaning people aren’t just going to Starbucks more often, they’re also buying more than just coffee.

Cold-pressed juices from Evolution Fresh and baked goods from La Boulange were successful during the first few months and are still in “early days,” according to chief financial officer Scott Maw, who told Food Business News the products were only about 50 percent rolled out.

The segment’s growth should continue to boost sales in the second quarter.

In a March 11 presentation at Bank of America Merrill Lynch, Starbucks executives cited such offerings as a “massive opportunity” since more than 30 million transactions a week don’t include any food items.

Aside from that, they also noted big plans to build 1,500 net new stores this year, and forecast a minimum revenue growth of 10 percent, thanks to a “renewed focus on tea,” with Starbucks' specialty Teavana locations, along with “single-serve leadership.”

Another important source of growth for Starbucks is branded products such as Seattle’s Best bagged coffee, Verisimo coffee makers and single-serve K-cups, all of which are sold outside of retail locations, which they refer to as “channel development.”

The Barclays analysts predict that this segment “will start to see meaningful margin expansion in fiscal 2014,” despite the costs associated with launching new products and “formidable threats in both the retail and wholesale channels.”  

Analysts at William Blair wrote that growth in K-cup sales moderated slightly, with the company’s market share dropping to 21 percent from 22 percent the quarter before. However, it’s still up from just 17 percent during the same period last year.

They expect operating margin to rise 380 basis points in the segment to 31.6 percent, due to lower coffee costs.

Although coffee futures are up more than 60 percent since the end of January due to a drought in Brazil, Starbucks contracts its purchases months or even years out and shouldn’t be affected.

“With Starbucks already fully locked in for its coffee needs for fiscal 2014, we do not expect any impact this year from the recent spike,” wrote the analysts, whose revenue estimates were in line with consensus.

Another development during the quarter as an April 16 announcement that the company would move uts European headquarters from Amsterdam to London, with plans to “pay more tax in the U.K.,” after reports that Starbucks was paying very little taxes there, despite making more than $2 billion profit, according to a 2012 Reuters report.   

The company has also made a variety of new executive appointments, including the promotion of Chief Financial Officer Troy Alstead to the position of chief operating officer, to create a new leadership structure that will help it gain “maximum benefit from the retail, consumer, mobile and digital shifts currently underway in the global marketplace,” according to a press release. 

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