It seems that things are not going well for Starbucks (SBUX) at the moment. Third quarter results showed some improvement in the top line, while devastated investors experienced a fall in the bottom line. Revenue increased by over 12% year-over-year, to $3.79 billion in the third quarter in 2013. On the other hand, net income declined from $359 million in the year over third quarter, posting a net loss of over $1.2 billion in the third quarter this year. Still, on the stock performance front, it impressed its investors with a growth of approximately 48% in the year-to-date period.
The question raised here is: will Starbucks continue its bull run in the coming quarter? Let's find out whether there are any fundamental changes that will give an extra push to the stock price of the company.
Presently, there are four major areas in which Starbucks is aiming to grow: the La Boulange brand, drive-thrus, a lunch menu, and the Teavana stores.
The existing pastries available at Starbucks stores will be replaced by sweets from the La Boulange brand, a French bakery that serves pastries, organic breads, and desserts. Since the pastries are now heated, and then served, more and more customers are liking this change. I believe these new and improved food offerings will boost purchases, and create a new "meal occasion." It will be one of the important driving factors for both customer traffic and sales growth.
Starbucks is presently penetrating the selection of drive thrus in the United States. I expect this to push the top-line in the next two years, as two-thirds of this year's building expansion includes drive thrus.
On the other hand, Starbucks is in test mode, in terms of a lunch menu in certain locations in the United States. The company is considering this addition to the menu as a totally new opportunity, which will also help in broadening the customer base.
Appealing to the tea drinkers, this past fall Starbucks opened its first flagship Teavana store at New York City. Starbucks is planning to open nearly 1,000 Teavana cafes in the next two years. At this point of time, Starbucks is considering this as a high profile baby step into the global tea market valued at $90 billion. Since Teavana tea contributes merely 1% of total sales, I am anticipating a high-level penetration strategy to be adopted by Starbucks in the next two years.
Europe - The New Expansion Point of Franchise
Looking back, you will see that Starbucks has often avoided the 'franchise' form of business. Its peer companies, like McDonald's (MCD), Wendy's (WEN), and Burger King (BKW) have considered franchising as a valuable form of operating their business. All of these companies have been successful in the United States as well as other regions around the globe.
By franchising, it becomes easy for these companies to decrease the level of volatility of their business, not to mention they earn substantial income in the form of royalty fees received from franchisees. In fact, Burger King and Wendy's are presently selling company-owned outlets to the franchisees.
Based on this success, Starbucks seems to be changing its strategy and now aims to open more franchise outlets, rather than company-owned, or is considering the joint venture strategy, as it did in India and China last year. One of the reasons for this change in strategy is that Starbucks wasn't doing enough business in the European region, since most of its stores were opened in ritzy locations. After shutting down a few of its stores, and concentrating more on the stores that were bringing in higher revenues, the operating margin of Starbucks grew to around $64 million in this fiscal year's results, past the falling streak posted in the 2012 fiscal year. In addition to this increase, restaurant traffic grew by 3% in September, ending the quarter.
As per the expansion plans of Starbucks for this fiscal year, it will be opening nearly 200 stores in Europe, the Middle East and the African region, which will include over 75% of licensees, or franchisees. This is in line with the development of various loyalty programs, with which Starbucks has experienced immense success in the United States, and with localizing the design of the stores Starbucks has opened in the more mainstream areas of Europe. Overall, I believe this strategy will aid the flow of revenue from the European region; further improvement in operating margins will also boost the company's bottom line.
Mondelez Also Considers Expansion in the European Market
Last month, Starbucks lost a lawsuit against Kraft (KRFT), which resulted in Mondelez (MDLZ) winning nearly $2.57 billion from Starbucks. This payout will help Mondelez not only to conduct share repurchase programs but also to expand its business in the European region. This decision is in a large part based on the growing popularity of Oreo and belVita brands in Europe, whose revenues have increased by 25% and 18% respectively since 2009. To cater to this growing demand, Mondelez will be opening a state-of-the-art biscuit manufacturing plant in Opava, Czech Republic. With this manufacturing facility, Mondelez will be in position to produce over a million biscuits per day. The sales, operating margins and the profits will all reflect a positive impact upon completion of this plant.
Since 2010, Starbucks has been providing dividends to its shareholders every quarter. It also provides a raise in quarterly dividend earnings each year. Based on its historical pattern, I expect Starbucks to pay a dividend of $0.26 per share by February of this year. It currently has a dividend yield of 1.3%, which is in par with its industry average.
In terms of wealth, Starbucks has a price-to-book ratio of 13 times, as of the trailing 12-month period. This is much higher than the industry average of 7.5 times, in the same period. On the other hand, its ROE stands at 0.18%, as it reported net income of $481 million in the last quarter of the 2013 fiscal year. The industry average ROE stands at 27.4%. Overall, Starbucks proves to be an overvalued stock. Given the present overvalued attributes of its stock, and the fact that Starbucks recently lost the case against Kraft, I recommend a taking long-term position in this stock. In the short term, the stock may experience a decline, but it has strong fundamentals to support business in the upcoming years, and I anticipate continuous momentum for growth in the long run.