Why Starbucks Is A Lucrative Investment

Oct.15.13 | About: Starbucks Corporation (SBUX)

Starbucks (SBUX) has been expanding its footprint in China by opening new stores. It observed solid sales growth of 29% year over year from the Asia-Pacific region in its third quarter of this year. New store openings in China supported this growth. It foresees China becoming its second largest market over the next few years. Along with its focus on China, Starbucks has recently filed a trademark on a beverage-making machine called Fizzio.

Coffee giant's success mantra for China

Starbucks has been operating in China for around 13 years and is currently focusing on expanding its stores as part of its international expansion growth strategy. It is planning to open its 1,000th store in China by the end of this year and is looking forward to making the world's most populous country, its second largest market after the U.S.

The coffee giant has successfully entered the predominantly tea-drinking culture of the Chinese market and is slowly gaining popularity in the country. Starbucks' mantra for success is similar to that of its western markets, with a little difference. The company continues to focus on its core food and beverage offerings but it has also developed some new products that appeal to local tastes, and its stores are to support a dine-in experience. Respecting the tea culture of China, Starbucks launched a range of Starbucks brand teas in 2010; this helped the company expand in China. This makes Starbucks different from other western companies trying to bring their same menu offered in their home countries. Starbucks targets the more affluent group, as they are typically acclimated to the western coffee culture. Starbuck stores in China make 70% of their business in the late afternoon by having enough space to accommodate customers who linger for hours.

Starbucks is constantly working to catch Chinese customers' attention. The company's stores have eye-catching interior and exterior designs and new locations to delight customers with an elevated 'Starbucks Experience'. It recently opened two flagship stores in China. The new "coffee tribute" store is located at the Kerry Center in Beijing, and 'eclectic chic' is a 24-hour store in the heart of the Taikoo Li Sanlitum, Beijing.

In recent years, the Chinese market has surged at a rate of 15% annually and is expected to increase from $11.27 billion to $160.94 billion over the next ten years. According to a Euromonitor report, the company has 60% share of China's emerging coffee house market, above its competitors. Starbucks has ample room for growth in the Chinese market over the next few years. Despite facing the big challenge of replacing tea with coffee, we expect Starbucks to continue making huge profit from China. It should remain popular among the younger generation and affluent customers because of its quality and brand reputation. The company foresees China to become its second largest market over the next few years and plans have around 1,500 stores in the country by 2015.

Entering the Home-Carbonation game

Since June, Starbucks has been testing its carbonated drinks in Atlanta and Austin, and recently filed a trademark for its beverage-making machine Fizzio. It plans to launch this new machine with a wide range of soft drinks. The company has been testing three flavors- Lemon Ale, Spiced Root Beer, and Original Ginger Ale. In addition, it is also providing customers the option to carbonate other drinks like iced coffee and iced tea, at no extra cost. All three drinks in the test range are handcrafted and don't contain any artificial colors, preservatives, or high-fructose syrup. According to a spokesperson for Starbucks, the company is receiving a positive response from its customers in the test markets.

Starbucks joins the Israeli manufacturer SodaStream (SODA), and its major competitor Green Mountain (GMCR), which filed a trademark for its "Karbon" beverage machine this summer. Green Mountain currently brews Dr Pepper Snapple flavored iced tea, hot apple cider, or Swiss Miss hot chocolate, and is looking to expand mainly to juices, soda, and sports drinks. Green Mountain's single-serve Keurig machine has gained more traction, compared to Starbucks Verismo because it is cheaper. Keurig and Verismo both serve hot beverages.

Starbucks also sells its "Verismo" home espresso and latte maker for home use, whereas, Green Mountain sells Keurig single-serve hot beverage machines to restaurants and coffeehouses in addition to individuals.

While competing with Verismo, Keurig dominates the at-home segment with an 80% to 90% share. All the factors make Verismo less cost effective compared to Keurig.

We expect that Starbucks Fizzio will gain more traction through its broad range of drinks, helping the company capture a major portion with its expertise and brand dominance in the market.

SodaStream's machine allows users to make carbonated colas, energy drinks, lemonade, and iced teas easily at home using ordinary tap water. The company has more than 100 types of concentrated syrups and flavors, which make it easy for users to create their own beverages. In addition, the machine also has a variation "Milkstream" for making milkshakes.

If Starbucks expands in the U.S. soft drink market and enables other restaurants to serve soda through its Fizzio, then it could become a part of a $77 billion carbonated beverage category and expand beyond coffee in its more than 19,000 branches around the world.

Valuation

 

 

Company

Profit Margin

ROE

Trailing 12 months P/E

Forward 12 months P/E

Starbucks

11.06%

28.74%

37.05

28.99

SodaStream

9.94%

18.18%

28.62

19.94

Green Mountain

10.53%

18.77%

26.06

19.98

Click to enlarge

Source: Yahoo Finance

All three companies are expected to do well in the future. According to their forward PE comparison, Starbucks is expected to generate higher earnings compared to SodaStream and Green Mountain. In terms of profit margin, Starbucks' 11.06% profit margin denotes that its pricing and cost strategies are strongly controlled compared to its peers. If we compared the ROE, Starbucks' ROE of 28.74% makes it a better option over its peers for investment.

Conclusion

We believe that Starbucks has a huge opportunity waiting in the soft drink market which can result in surge of sales in the coming years. The company's quality and brand popularity should help Fizzio gain traction and generate huge profits. We believe these initiatives should bring positive growth. The fantastic growth opportunity that lies in China will take company's sales to a higher level, which will help generate higher revenue in the coming years. The above factors and valuation indicate that this stock an attractive option for investment.


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.

Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Shweta Dubey, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.