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Summary

  • In the latest quarter, Starbucks reported top line growth that beat its rivals and bested its estimates in every region; it also posted higher transactions and bigger tickets.
  • The hedging of coffee costs for the next year should bring in more stable income and allow the company to have more pricing power.
  • The Chinese expansion, strengthening the tea culture, and other initiatives should continue to boost the top line while coffee costs remain hedged.

Starbucks's (NASDAQ:SBUX) share price has hiked 21% in a year. During May of last year, the company challenged competitors by lowering the price of coffee sold in retail outlets by $1 for its brands such as Seattle's Best. The plan enabled Starbucks to build up its market share. To date, the company continues going strong, as shown in the latest quarter's report. In an arena where many industries that previously performed well are declining as the economic climate changes, coffee and certain staples haven't been affected to a material extent, relatively.

In this article, we will analyze Starbucks' performance. I will first go through the quarterly results announced this week. Later, we will discuss the future potential of this fast-growing coffee chain.

Third Quarter

Source: Earnings Release

Starbucks' total revenue rose 11% to $4.2 billion with global comparable sales increasing 6%. The coffee industry isn't significantly affected by the changing economic climate. This is seen in the growth rate that continued to grow by more than 5% for the 18th consecutive quarter. Continued rollout of Teavana teas, La Boulange pastries and sandwiches, and the introduction of carbonated drinks helped Starbucks to achieve this expansion.

Domestically, sales rose by 6%. Starbucks' closest competitor, Dunkin' Donuts (NASDAQ:DNKN), reported an increase of 1.8%. Even the rival's managements cited swelling competition in the breakfast category which Starbucks won by a wide margin. Part of the explanation for this was the fact that Starbucks' breakfast sandwich supply increased by a whopping 40% since last year.

Source: Earnings Release

So while it can be said that not everyone was performing well, Starbucks still came out as a leader. The table above shows the comparable growth across other regions. The Chinese region is growing really fast. The total growth rate of 7% includes 6% from more transactions with just a small portion from bigger tickets. The operating margin expanded 200 bps to a record 18.5%, primarily driven by sales leverage, with earnings per share also reaching a record level of 67 cents, bringing an increase of 22% compared to last year's figure. Some of this increase was brought by lower bottom line pressures. This is because there had previously been concerns that coffee bean prices would impact the top line due to fears surrounding Brazil's coffee crop this year. However, recent rains have removed those concerns.

Coffee costs make up a huge component of Starbucks' expenses. A guaranteed price for the future allows investors as well as the company the ability to prepare ahead. Starbucks has hedged its coffee prices below this year's level for 60% of its coffee demand in 2015. This lower volatility of costs should help drive a more fruitful result in the near future. A guaranteed price also gives the company pricing power over its rivals. With this hedge, we can safely rely on the company's estimated figures. Starbucks expects earnings growth of 15%-20% for the coming year.

The My Starbucks Rewards [MSR] loyalty program is proving to be successful and will add further sales to the portfolio. MSR transactions now account for over 40% of total sales, and it shows that the company is able to penetrate the Chinese market and develop positive customer relationships through this targeted one-to-one marketing initiative.

Even coffee sales are doing well in China. The strawberry cheesecake Frappuccino set instant records for the top-selling limited time Frappuccino ever introduced in the region. For those who don't want to rely on coffee sales alone, allow me to put more emphasis on the tea brands the company is promoting. Starbucks introduced its Oprah Chai, a version of tea marketed with Oprah Winfrey, in the domestic market. The Chinese are more tea oriented, and this expansion could be more heavily targeted abroad in China. As the company opens nearly 800 stores in China next year, we can expect comparable sales figure to bring in additional top line.

Bottom Line

The coffee business is performing well. Consumers like Starbucks' innovative new products. With tea as an alternative for growth, the untapped Chinese market and bottom line pressures under control, the company's positive stock price trend should continue in the future. Even if the competition intensifies, Starbucks can lower its prices to challenge its competitors. The expansion operations in other regions are positive too, and Starbucks recently opened its first store in Bogota, Columbia. Starbucks appears to have its operations under control and therefore, I recommend buying the stock.

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

Source: Starbucks Is Still A Challenge To Its Rivals