Starbucks: Quality Has Two Faces

| About: Starbucks Corporation (SBUX)

Summary

Starbucks is still underrepresented in EMEA.

The brand name is associated with quality.

Premium prices may scare younger customers away.

Since its height in November 2013 ($82) the SBUX stock fell almost by 24% until it hit the bottom on April 2014 ($69). From this point on it seems that the trend shifted from being bearish to bullish. So the question is, which factors hold the stock back during the last few months and which factors contribute to a positive outlook.

Howard Schultz, the CEO of the company, pointed out that Starbucks experienced 17 consecutive quarters of a comp revenue growth of 5% or higher. That is per se a good sign. Starbucks only has 20,000 stores in 64 countries. Of course, this number may sound good, but most of these shops are situated in the United States and Canada. In many other countries, especially in Africa and Europe, the brand is not yet well established.

Just to name one example: There is not one single Starbucks on the Mediterranean Republic of Malta. And one might ask what makes these small islands so important. Malta is a major tourist destination for many Europeans, especially for tourists from Great Britain and Scandinavia. During the summer season the small islands experience a peak consisting of younger tourists looking for parties and language schools. During the winter season Malta experiences another peak consisting of mainly elder tourists who like to enjoy some sunny weeks in winter. Therefore, the year-round tourist destination is home of all the well-known brands like McDonald's, Burger King, KFC etc. as many tourists and especially the younger generation prefer to eat and drink at those well-known restaurant chains. McDonald's reacted soon and established its McCafé in St. Julians, a city preferred by the youngsters. The main island is pretty small and city life is focused on the northern coast. This is why restaurants - especially the big chains mentioned above - are usually highly frequented. But as of today tourists won't find a single Starbucks. Not even in Valetta, Malta's capital.

The reader may think that Malta may be just too small for another coffee brand without enough room for growth or that the resentment in Malta is even stronger than in other European cities/areas etc. Yet this is not the case. The vast majority of tourists visiting Malta is British. Starbucks currently operates well more than 300 shops in the UK alone, employing more than 9,500 people there. So, it is not the question if a Starbucks would be accepted in Malta. Since Malta profits from being a new part of the European Union many building projects for EU citizens who wish to move to the islands came up during the last few years. The building projects also include new hotels. Thus, there is room for growth although the competition will be tough.

Malta is just one (and in fact a very small) example for Starbucks' unused potential. But it makes clear that Schultz's aim to successfully expand the brand and gain new customers is absolutely realistic. Another figure will underline this argument: According to Schultz only 2,065 of the 20,000 worldwide operated shops are in Europe, the Middle East and Africa combined. On the other hand, McDonald's has already successfully established its McCafé branch in Europe. The competition is tough.

However, another promising approach is the Teavana brand. Coffee alone does not sell well. And not everyone drinks coffee. If a group of five meets at a Starbucks, it is well possible that two out of this group prefer another drink than coffee. Since tea is one of the most popular drinks in the world, yes, even the most popular drink after water, Teavana is likely to generate additional sales and boost the operational income that rose by $100 to $644. Moreover, The Coffee Bean is a good example that the combination of tea and coffee can work.

The third promising factor is the vertical integration approach of the company. With its first coffee farm in Costa Rica, Starbucks can not only control the sale of its main product but also its production. This is very likely to decrease spending and therefore to cut operational costs.

Given the fact that the struggle with Kraft Foods held the company's stock back during the last two quarters, we could expect the stock reaching $78 in the next three to four months since the $2.78 billion paid to Kraft Foods to settle the dispute over coffee distribution were charged to the 2013 operating expenses. Therefore, it will not affect the 2014 operating costs as much, because the company said it had "adequate cash capacity" and did not have to borrow the entire sum. But then again we have to shift our focus from Starbucks' expansion plans to the company's image and to what the brand has to offer.

Starbucks as a brand is worldwide known as a high quality coffee shop. A more or less positive image is always a good thing. But the company does not only offer coffee, but also bakeries, sandwiches, tea and its new refreshing drinks. Especially for frequent travelers it is a certain advantage that the menu is almost the same in every Starbucks store around the world with only minor exceptions. People who like their quality coffee and who are willing to pay for it go to Starbucks.

But here is the other side: Whereas the brand stands for premium quality to some, others think of it simply as a coffee shop with obscene prices. On the other hand, the company defends its price policy with its responsible purchasing practices and its participation in Fairtrade. This policy might be respected by the elder generations, but especially the younger generations do not seem to care, but rather focus on the money they have to put down for a coffee. And although Schultz mentioned proudly that "sandwich sales lifted by nearly 50%" it is hard not to find $8 for a sandwich obscene, when you see that the very same sandwich with the very same filling on the gas station across the street for half the price.

And it is this premium pricing that could ruin Starbucks as a brand - at least in Europe. If you visit any European city without a Starbucks and ask someone where the next Starbucks is, he or she might say "We don't have them in this city" and might add "which is a good thing." And it is especially the European youth that seems to have a growing resentment against the company's high prices. This might also be the case since competition in Europe is very high. When Schultz says he wants to expand the leadership of the brand, he needs to be aware that the company still needs to prove that leadership in Europe.

When I think of Starbucks, I think of high quality and premium coffee. But exaggerated prices could scare customers away. And the sandwich sales for 8$ a sandwich seems to be a dead end in the long run. As for the stock Starbucks is heading in the right direction: The company focuses on expansion, which is badly needed to unleash its full potential in the EMEA and its brand name is linked to quality. Yet, premium prices could severely damage Starbucks' worldwide image and this would lead to just another bearish trend.

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.