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Starbucks Corp. (NASDAQ:SBUX) has been diversifying into food products and the move is beginning to pay dividends by increasing footfalls in stores in the U.S. translating into enhanced revenues and profits. The world's largest operator of coffee shops has introduced a food menu with items such as salads with zesty chicken flavoring as well as black bean. The company has entered into a partnership with Danone SA (OTCQX:DANOY) for the preparation and sale of Greek yogurt through cafes and supermarkets and it is adding baked goods from La Boulange in the United States.

Third quarter financials

Starbucks reported strong performance in its fiscal third quarter with a 25% increase in net income to $417.9 million translating into an EPS of $0.55 per share compared to $331 million and $0.43 per share in the same quarter of the previous year. This was ahead of the consensus EPS estimates of $0.53. Revenue grew by 13% to $3.74 billion in the quarter ended June 30, and analysts estimate it will grow by 12% to $14.8 billion in fiscal 2013. Chief Financial Officer Troy Alstead said that foods had been phenomenal for the company adding that refreshers energy drinks and macchiato espresso coffees also contributed to U.S. sales during the quarter.

Price increases and profit expectations

Sales at stores open for at least 13 months grew by 9% in the Americas and exceeded the 6.1% average consensus estimate. The company also raised prices for some drinks at company operated outlets last month which was in many cases the first price increases in two years. One analyst said that because the products are positioned as affordable luxuries, consumers are not particularly price sensitive and are not put off by reasonable price increases. Starbucks has increased its estimate of profit for fiscal 2013 to an EPS of $2.23 per share against their previous estimate of $2.18 per share and analysts estimate on average of $2.18 per share. In the company's fourth quarter, profit is expected to be $0.60 per share (including $0.03 per share from the sale of operations in Chile and Argentina) against an average an analysts' consensus estimate of $0.57 per share.

Lower coffee bean prices

The lower prices of coffee beans are contributing to increased margins and may boost fourth quarter earnings by $0.02 per share. The company has already locked into the lower prices for about 4/5 of its 2014 requirements. It has reduced prices by about 10% on the bagged coffee it sells through retail stores and also reduced prices for its Seattle's Best brand packaged beans. It is also trying to increase sales through grocery stores by selling Evolution Fresh juice to which it has added Tazo tea and bottled beverages.

Business in China

Starbucks is selling more coffee in China. As reported in the latest quarter, there was a 30% increase in revenues in the Asia Pacific region over the same quarter of the previous year driven by booming sales in China. Analysts say that the strong performance is sufficient to prove that coffee can be successful even in countries that traditionally drink tea. The growth in the region was primarily due to the 500 new stores opened in China last year and the company plans to take this footprint to 1000 new stores by the end of 2013. In addition, stores will open in cities other than Beijing and Shanghai and the company expects China to overtake Canada as its second biggest market after the United States by 2014. The marketing strategy in China focuses on core products like the West to capitalize on the fact that the average consumption of coffee in China is 2 cups per person per year compared to the global average of 134 cups. Moreover, coffee makes up less than 1% of the Chinese hot drink market compared to 54% for tea.

The bottom line

Starbucks uses both volume and pricing to grow its revenues and traffic growth is pretty well distributed. The company is expanding its product lines with the anticipation of driving further same store sales into the future. This combined with their ability to increase prices to consumers and decreases in input costs should not only allow the company to increase revenue but strengthen margins allowing them to increase the bottom line at an even faster pace. Though the company is still heavily reliant on the United States from where it derives 75% of its sales, it looks as if the geographical diversification as well as the expanded range of products is beginning to pay off and emerging country growth is starting to look impressive. I believe that there is at least a 20% upside to the current price of nearly $74.00 because of the solid revenue growth prospects globally.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Starbucks Stock Has At Least 20% Upside

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