Troy Alstead - CFO and CAO
JoAnn DeGrande - VP, IR
Andrew Barish - Jefferies & Company
Starbucks Corporation (SBUX) Jefferies Global Consumer Conference June 18, 2013 9:30 AM ET
Andrew Barish - Jefferies & Company
Thanks a lot. We will keep things moving along this morning with the leading specialty coffee retailer in the world, Starbucks. Very pleased to have Troy Alstead, the CFO, looming behind me here and JoAnn DeGrande, who runs the Investor Relations function at the dais or table or whatever we want to call that.
The Company has – had a very significant run since some challenges that they addressed very quickly and swiftly in the downturn or recession, and I think probably puts Starbucks which is many of you know has been a remarkable growth story on more solid footing than at any time I think I can remember in terms of just core fundamentals in terms of the top line profitability and growth.
And with that, I will stop and let Troy tell you the real story.
Thank you, Andy. Good morning, everyone. It’s great to be here. The store behind me is a store that is opened about a year and half ago in South of Seattle. It’s in the industrial area, near the Port of Seattle, it’s made from four reclaimed shipping containers that’s LEED-certified as our – all of our – the goal for all of our new stores we build going forward. This is a highly profitable drive-thru store with also a walk-up window and many people use it as a bike up window as well. It’s in a great location. It is one mini national and international designer works for the innovation of this design, and it’s an example of our ability to continue to innovate against the store concept, the store design, while we also innovate against beverage opportunities, food and everything else we do in our business. So very good reflection of the growth opportunities we have to come and incidentally if we ever had to relocate the store, that will be quite easy to do.
Starbucks has always been a growth Company, since the early days as a privately held Company and then over the last two decades as a publicly traded Company, we have been defined as a growth Company largely during that period of time by growth in new stores and particularly for much of that history growth in new stores within the U.S.
Since the difficulties of 2008 and 2009, we’ve really diversified and matured our growth strategies crafted a whole new set of strategies and plans and initiatives around driving growth multi-dimensionally throughout the business. And I will spend a little bit of time this morning taking you through a few of those, what we believe to be the most significant opportunities we have.
We are targeting to deliver 10% or greater revenue growth on sustainable annual basis. In 2012, we delivered revenue growth of 12% – 14% excuse me, in this current fiscal year, fiscal ’13. We anticipate by the end of the year driving revenue growth between 10% and 13% and I think by the time we get towards the end of the year, we will be right somewhere in the middle of that range.
We are also targeting – leveraging at 10% revenue growth into more rapid earnings growth as we expand margins over this period of time. Targeting 15% to 20% sustainable growth in earnings and over the past three years we’ve delivered compound growth rate and earnings of 19%. So towards the top end of that sustainable range that we’re driving for, and in this current fiscal year our current year target ranges between 18% and 22% earnings growth with a significant number of investments we’re making back into the business this year could drive growth in future years and then benefited a bit by commodities favorable this year after a few years of some difficulties in commodities that’s helping boost us for the top-end of that range and perhaps tipping a little bit beyond that 15% to 20% range that we’re targeted.
Now the opportunities that we faced are multiple and they include the traditional store growth that we’ve historically executed very well, but also a range of those. And I intend to take you through a few of those highlights today.
Starting with food. Food ranges around the world within a Starbucks store from a low end of about 10% of the sales mix in some markets around the world to a high-end nearing 30% in other markets around the world. In the U.S., food is about 19% of the sales mix within a store. Approximately 1/3 of our transactions in U.S. stores have a food item on them. 2/3s of those transactions do not have food on them and that really represents the opportunity as we see it. Of those 2/3s of the people, 50 million to 60 million customers coming into our stores every week many of those 2/3s of the people want food. We’ve already acquired that customer. They have come in the store, they’re interested in food, they’re ready to give us money and yet the barriers historically to us capturing more of that 2/3s have really been two-fold as we understand our customer.
One has been our food often historically has not met their expectations; it’s not been up to the quality they expect when they come into Starbucks. The second area has been it hasn’t always matched the occasion, so the daypart. In our early days, our food was primarily oriented toward that morning daypart. We didn’t have lunch offerings; we didn’t have something that was appropriate in the afternoon, if the customer was coming in.
Over the last several years we really significantly addressed and began – continue to address both of those barriers by elevating the quality of our food, by improving execution in the store and also by increasingly innovating just as we do with beverages innovating against the dayparts, going after that midday daypart.
Innovating with food into the afternoon and evening where we know in those dayparts food is a more meaningful driver of that customer’s decision to come in the store than it is in the morning where it’s primarily a beverage focused transaction. The result of that has been not that many years ago food being in the low teens as a percent of sales in the U.S. with a much lower attach rate. We’ve slowly, but surely been addressing the barriers to that customer purchase and moving that sales mix and that attach rate higher. And that’s all before the La Boulange acquisition. What has encouraged us going forward is the early results of our new food program starting with bakery, with the La Boulange execution first in the Bay Area, more broadly in Northern California, very recently in the Seattle market as we just launched there a week ago and then we will continue to launching this new bakery program city by city across the U.S. over the balance of this year and for about the next 18 months before we’re fully penetrated.
The confidence we’ve had from what we’ve done with food and years passed in the early – very early results we’re seeing in our new markets with La Boulange gives us confidence in our ability to continue driving that attach rate higher and driving the sales mix in food higher. What’s important about food is, it has two opportunities here. One is to attach more food to those existing transaction, those customers who are already in the store. We also know that food can be a driver of traffic. It can create an opportunity for somebody to come in, in the afternoon at midday when perhaps otherwise they would have made a different choice. And better food also sells more beverage, so we see a tremendous opportunity here with food as a consistent driver of growth over time.
Now as excited as we’re about food, the core, the largest part of our sales mix, the core of our business and where we’ve significantly continued to innovate is within the beverage category. Just in the second quarter alone we had three points of incremental comp coming from new beverage innovations. Three particular products shown here actually refreshes platform which was a – an entirely new platform, not just a product, a platform of products that we’ve launched for the first time last summer. Its going after an entirely different consumer need state, that refreshment category that we had not historically really addressed in our portfolio of product offerings. It really targets an entirely new daypart. It helps stretch people into that underleveraged time of the day when we have significant opportunity and by itself added about a point of incremental comp in that second quarter that we just reported.
I also list up here two other beverage innovations that are right in the heart of what we do. Hazelnut Macchiato and Vanilla Spice Latte. I call out that in particular because together, they give us about two points of incremental comp in that second quarter, but particularly to make that point that those espresso beverages are right down the middle of where the largest part of our sales mix is within the store, in that espresso category. And it’s even in that large very matured, very established category within the Starbucks store; we continue to innovate and clearly continue to have opportunity to drive incremental volumes through the stores, very profitably with beverage innovation.
I mentioned the store up front and I will comment on stores here again. Now our store opportunity going forward is both as we remodel stores, this is a Time Square store that we remodeled about a year, year and a half ago. It is the number one volume store in the U.S. for us at about $6 million AUV. And it’s representative of our ability to take existing stores and either remodel and in some cases expand where that opportunity exists, create a significant brand platform and drive significant volumes through those stores.
Now, not every location in the country or in the world is a Time Square kind of traffic location. Our second highest volume store is the Pike Place store, in Seattle, 400 square feet, a limited offering, there is no food offered in the store. It’s really the original of the concept only with beverages in the store, and yet this is a $5.5 million AUV that continues to comp very strongly, profitability four wall cash profit in the store is in the upper 30s. It’s a very good representation of our ability through a relatively small footprint to continue to grow and innovate and drive continued traffic over time.
Third highest volume store in the U.S. is traveling all the way down to Houston, where we have this drive-thru stores, it’s a beautiful store. It’s an extremely high volume store, and it’s reflective of our opportunity as we go forward about adding drive-thrus increasingly into the mix. About 40% of our U.S. portfolio today is in drive-thru stores.
Going forward, our growth in new stores in the U.S. will be about 60% drive-thrus or greater as we continue to recognize in ongoing opportunity to get better how we operationalize to the drive-thru, and then also how that opens up new real estate opportunities for us. By the way we are increasingly looking at drive-thrus in selected markets around the world where we are highly under penetrated, but recognize we have a significant opportunity.
Now if any of you who have ever traveled between LA and Bakersfield, California you’ll know that there’s not a whole lot there. But right in the middle of that stretch there is a Starbucks drive-thru store. That is in the top 5 volume stores in the U.S. for us as well and again represents and underscores the opportunity for us with drive-thrus, but also increasingly as we have sharpened our abilities around our supply chain into our stores as we deepened our capabilities around operating profitably as we’ve increasingly managed our ability to select sites and execute those sites, it's opened up for us increasing opportunities for real estate and it represents an example of why we continue to believe that even in the U.S. where we have our – obviously our longest standing market place than most stores anywhere in the world that we continue to add 100’s of new stores pre year here within the U.S. both by adding depth within existing trade areas and in many cases reaching at new market opportunities that we couldn’t have reached historically.
In the last several years in particular, really since the challenges of 2008 and 2009 we had significantly deepened our capabilities around real estate site selection, around understanding trade areas, around store design, around innovating, around the concept. We’ve become much better operators of stores within the stores about managing waste and managing and deploying labor. We have become much more selective about how to size the store for a particular trade area. We understand cannibalization than we ever have before and that has opened up all kinds of innovative dept of opportunities for us including a ski-up store that you see here in one of the ski areas including a store that will open up here in few months. It's a train car that’s actually in the Swiss Train System, an entire Starbucks store that will travel with that train and we’re very excited about that opportunity, and it's reflective of our opportunities in the U.S. and around the world.
Now, tea is the second most consumed beverage in the world, secondly to water. It's an ancient beverage and yet at the same time it is a beverage platform and category that has many new innovative exciting things happening with it in the U.S. and around the world, as there is a bit of a revitalization in consumers interest around tea recognizing its health and wellness benefits and the aspects of tea. And with all that said, tea for Starbucks has remained in the single digits share of sales within a Starbucks store.
Now tea has been in the name of Starbucks when we opened the concept, Starbucks Coffee, Tea and Spices were back in 1971. We have equities in this space, we have customer information in this space, and yet it has never had the focus and attention in our stores and outside of our stores that we can now bring to it. We are very excited about tea as an opportunity in our stores in the Teavana acquisition that we completed just recently brings with it three propositions, three growth opportunities. One is to continue rolling the Teavana store out by bringing together the deep capabilities that the Teavana team has in tea sourcing, in blending and R&D that they’re very deep and strong in, as well as their merchandizing capabilities within the existing Teavana stores and combining that with what Starbucks does well, store operations, store design, labor deployment, site selection and importantly beverage execution and innovation.
A new generation of Teavana stores will begin opening up this fall, will look and feel much like Teavana of old, but will bring with it new owners to beverage in execution and innovation in store that we believe will add a new layer of growth and open up significant growth opportunities for the Teavana standalone concept in the years ahead. We are very excited to begin rolling that across the U.S. again starting in New York and beginning this fall and ultimately there’s tremendous opportunities we know around the world for a contemporary tea house concept that we believe we can execute quite effectively.
The second strategy and leg of growth for tea for us is to now deepen our key presence within the Starbucks stores to really use tea as a driver of another customer occasion, another customer visit. It's very complementary consumption time to coffee. Coffee to the American consumer tends to be busy and rapid and skewed toward the morning. Tea is a little more relaxing and Zen like and skews to the afternoon and evening and weekends. It's very complimentary to that existing asset that we have with Teavana’s capabilities around tea and our ability to bring beverage innovation in a focused way to tea just as we have to coffee and now to food. We believe we have an increasing opportunity to use tea as another layer of growth within the Starbucks store over time.
And in the third opportunity with Teavana in particular is to use that as a leverage point into CPG channels over time. Once we establish the brand more meaningfully, create awareness through Teavana stores and through the Starbucks stores we have an opportunity to extend that both in dry tea and ultimately perhaps ready to drink tea and other key innovations in a packaged format into the CPG channels over time. Another opportunity in geographically was China, Asia Pacific for us. Our cap region is the fastest growing region of the world for Starbucks. It's also the highest margin and highest return on capital region of the world for us. It continues to be a significant opportunity. And then China which gets a great deal of airtime and has a huge opportunity and will very soon become our second largest market anywhere in the world, but also in India a market we just opened a few months ago and are seeing tremendous earlier results from. Vietnam, also a new market we opened. Indonesia a place we’ve been in for many years now but has significant long-term opportunity both in store development and then outside of the store, products like ready to drink beverages for example we have a significant opportunity in many of these Asian markets to deepen our presence and expand the Starbucks reach into the consumer through our brands and products and channel opportunities.
Speaking of channel opportunities, channel development is a part of the business that consumers have pulled us to over the years with the deep history of Starbucks as you know being in the Starbuck store. We have come to recognize more strategically over time that there is a significant opportunity to go after customer occasions of our brands and products and the offerings we have outside of that Starbuck store. That is largely focused today in the U.S. with all of our products around packaged coffee, single-serve, ready to drink, VIA, many opportunities within that core of the coffee and tea space and some adjacencies right around that that we’re profitably developing and growing within the U.S. and increasing it outside of the U.S. It leaves us to believe that in the next five years channel development will be among the fastest growing parts of our business anywhere that we have as we continue to extend that -- again our reach to the consumer outside of the traditional Starbucks store.
All of that growth really empowered by what we do digitally. We had significant success in reaching our customers digitally, significant benefits both in terms of cost, but also the halo that comes from providing these opportunities around payment methods and loyalty to the customer. Starbucks card in all it's entirety and that means the physical card, but also mobile forms of card, store value card payments represents now greater than 30%, almost a third of transactions in our U.S. system. The loyalty program in the U.S. just introduced a couple of years ago represents now 25% and rapidly growing of our U.S. transaction.
Mobile payments not launched all that long ago represents greater than 10% now of our U.S. transaction but significant opportunities to again continue to drive the efficiencies, speed of service, a lower cost transaction within our store, a very sticky transaction by virtue of the fact that people have preloaded their money that we hold for them in anticipation of that coming transaction and increasingly an ability for us to harvest that information and really determine in the most effective ways over time to understand our customer to target products toward them and in the appropriate ways and the appropriate ways reach them with our messages.
All of that again represents a snapshot of where we today see our most significant growth opportunities. There’s many more beyond that, but perhaps I’ll pause at this point, hand it back to you Andy for any questions or any questions that you may have.
Andrew Barish - Jefferies & Company
Sure. I’ll kick things off. I was actually shocked to see the China food number at the bottom in the list, I thought if my recollection serves me correctly, when you originally opened in that market it was mostly an afternoon tea time food business, so can you kind of give us an update. It seems as if maybe the coffee culture is starting to take hold in China and it has obviously become much more of a beverage business?
Well it's always been skewed toward a beverage business, but when we opened up in China the day parts were yes skewed more towards mid day and into the afternoon with a very low almost non-existence morning occasion. What’s happened over time is, yes the beverage business has grown the awareness of Starbucks products in that learning and that experience around how to ask for a Starbucks beverage and how to enjoy those beverages and how to use the Starbucks concept, all that has grown over time. And yes that has more pronounced driven the beverage business in our stores which is very critical to our concept, and it's also driven the morning a bit faster where you really see that morning experience developing increasingly in China. We actually see the opportunity both to drive AUVs in China through food, through dayparts, through the frequency of that visit, but also increasingly through our beverage innovation and the attachment of food to it over time.
Andrew Barish - Jefferies & Company
And can you give us a – just a quick update on China unit economics sort of trend wise and are you seeing any as the Tier 1 cities get a little bit more crowded and competitive, have you seen any changes in that good or bad?
We’re still small and fairly early in our experiences in China. We have actually been in China since the late 90’s, but we reached something of a tipping point I would say, three or four years ago where all age these classes of stores really significantly elevated in terms of comp growth and volumes through those stores. I think that was about reaching an awareness in that marketplace. In our early days of extending that from the Tier 1 cities into Tier 2 and Tier 3 in those early days of development we saw very similar economics and sometimes stronger economics in Tier 2 and Tier 3 cities than we even saw in the more mature Tier 1 cities as we are selecting as you would expect us to do in the early days of any market entry, some of the best real estate in the market.
Now as we progress over the next many years we do expect that we will likely have very, very strong ongoing economics within China probably somewhat moderated from where they’ve been in these early days where we are largely cherry picking the right kinds of real estate. But with that said, we fully expect and we see today that the unit economics in China likely will always be the strongest at a unit economic level for us anywhere in the world.
Volumes remain lower than say in the benchmark U.S. business, but four-wall profitability and four-wall return on capital is very strong in China and we would anticipate that pattern to continue even as we penetrate within Tier 1 cities and again outside of the Tier 1.
Andrew Barish - Jefferies & Company
Thanks, but maybe your perspective as, you didn’t spend a lot of time but on K-Cup growth first of all maybe a quick snapshot of the new Green Mountain deal that you signed recently. And then secondly from a big picture or strategic perspective is there a, I guess a tipping point to use the term you just used, at some point with the growth in single-serve do you worry about consumption in the retail coffee house business or how have you looked at those occasions over say a five year period?
Yeah, let me speak to the last part first. The answer to that is a profound, no. Customers don’t make a trade largely between their at home consumption and consumption on the go in a coffee house, whether it's a Starbucks coffee house or somebody else’s, perhaps around the edge of some due by the way, but fundamentally that’s not a trade customers make. What we see is the significant opportunity, I think as a fact that point is evidenced by the fact that over the last several years as there has been an increasing attention to at home consumption on our part and on other peoples part and making consumption more convenient and easier at home through for example, most significantly the Keurig platform there’s been nothing but significant growth within the Starbucks stores. There really is no meaningful transaction there.
Well, we do have every aspiration to do is elevate our share of at home consumption while Starbucks has a nice share of coffee house consumption in the U.S. and something we’re continuing to deepen we believe over time and have opportunity to grow even further. We’ve always been under represented in at home coffee consumption. And when historically we would ask customers, why that is if you’re a loyal Starbucks customer, why don’t we get more of their share of consumption when they’re at home.
Historically, it's because we weren’t in the form factor that they were looking for at home. And that has lead us over the last several years to really aggressively innovate into this space providing more at home opportunities in packaged coffee, Starbucks high-quality flavored coffee’s and increasingly things like VIA and then a couple of years ago on the K-Cup platform.
Most consumption at home in the U.S. is in the low-pressure brewed category, and so our Green Mountain with Keurig have done a fantastic job placing their machine into people’s homes. The beauty of that platform is it's a very healthy economics for everybody in the business in single-serve who can make a proposition of it. But importantly as coffee becomes easier for people to consume, people consumed more. So we’re actually seeing higher consumption of coffee largely we believe driven by single-serve executions. Our strategy both on the Keurig platform and really respectably with all forms of single-serve in the U.S. and around the world over time is to be the coffee on other platforms.
We recognize that Starbucks is not an equipment company. We don’t have aspirations to becoming the equipment company. We have a fantastic partnership with Green Mountain who again has done an outstanding job placing their machines in millions of peoples homes over time and that relationship in partnership and what we believe to be the opportunity going forward lead us together with Green Mountain linked in and expand our relationship to more skew count to a longer term reflecting where this business is going. They’re an extremely innovative company, always things on the table for innovation around that single-serve beverage experience at home that we want to be a part of together with them and that is what lead us to together with them, extend that relationship.
Andrew Barish - Jefferies & Company
Question’s from the audience.
Yeah, some of those, so you’re right. The historical Teavana concept which has great unit economics and it's something we’re very happy with was largely a mall based merchant, a mercantile or retail execution of hard goods and dry goods. Going forward we will very much respect that because there’s fantastic economics and that’s a great experience for the consumer in that execution. But what we’re working together with the Teavana team on is bringing more of a beverage execution into it. Again, because our Starbucks capabilities are so strong and had a operationalize beverages, and how to innovate around beverages will add that as a layer into the store.
Now the dry goods and hard goods I expect will always remain a predominant part of that Teavana sales execution and the experience of that store. But we know we can add both a layer of sales and profitability into the store by making it a contemporary consumption tea beverage, teahouse kind of place. But also by having a more pronounced beverage execution in store, we think that will accrue to more sales of the hard goods in the stores as well. So the new somewhat evolved concept is what you’ll begin to see – seeing roll out this fall. Yes?
No, we don’t …
Andrew Barish - Jefferies & Company
Troy, can you do a quick paraphrase of the question just for the webcast?
Yes. Thank you. The question was is there any backlash if I represent it correctly or concerns we had with that regulations around caffeine or the FDA’s interest in that space or some of the things I think others have gotten in trouble with a little bit around high caffeine content. And the answer is no, we watch it extremely closely and always have, but if you step back and really watch Starbucks we have never significantly targeted high energy kind of beverages. We’ve never made a point that we’re going after the youth market with caffeine beverages. We’ve been very cautious representing what our concept represents.
Coffee and caffeine is one of the most studied beverages for centuries, in fact, it’s been around a long time. We’re quite confident that in the right use among our customers in the way we’re targeting it, that’s a very complimentary healthy beverage and not something that we’re concerned about with any regulations around. And again, I think it’s largely that how we positioned our brands and our products historically and how we intend to position it going forward. Yes?
Yeah, the question was for those who couldn’t hear it, I mentioned a lot of opportunities, what’s the biggest challenges we face? How we’re able to overcome it? I think no question the challenge we face and talk about together among the leadership team and with our Board frequently is on execution of all those things. We have significant opportunities, we have a very, very healthy and robust business today in the U.S., we have a growing and increasingly profitable business outside of the U.S. There are significant opportunities as I’ve gone through outside of the Starbucks store. Our opportunity and our challenges to execute effectively and stay on top of those as we go forward. It’s an area where we focus heavily, I’m quite confident in our ability to do it.
We have a deeper, stronger management team than we ever have had in our history. We’re far better today at allocating the depth of talents and resources against each of these initiatives. I started at Starbucks when we were privately held more than 20 years ago. Back then everybody did everything, because that was what its – not unlike most start-ups around the world, that’s what you do in those days.
Starbucks is a dramatically different Company today. We have depth of talent and specialists who are targeted and bring experience against each of these initiatives. And then we watch them and report on them and measure them closely. So, I’d say execution is our biggest challenge, but its something I’m quite confident in our ability to continue executing and delivering.
Andrew Barish - Jefferies & Company
I think with that, we’ll wrap up the session with Starbucks, and thank you very much for your time.