Starbucks: All The Coffee In China

Aug. 2.07 | About: Starbucks Corporation (SBUX)

My English grandparents would often say “Not for all the tea in China,” which is an old expression that equates to “all the money in the world.” Tea came to England from China and India back when Marco Polo had to carry it on a donkey, but the country became addicted fast and for centuries England had a tea economy.

Now this didn’t happen all at once but, even in America, we have a passing familiarity with the East India Tea Company. Founded in 1600, the company gained a monopolistic control over India and the surrounding countries and eventually grew so large it had its own army! It was the East India Company’s tea that our patriots dumped in the river during the Boston Tea Party.

So love them or hate them, that East India Company made a lot of money for a couple of hundred years, and that’s longer than most empires last. Like many empires, the demise of the EIC was a result of overexpansion (in their case into being a quasi government).

But I titled this 'all the coffee in China' for a reason. Sales of coffee in China are rising 50% per year and the vanguards of this expansion are two foreign companies: Manabe, a Japanese concern and Starbucks, our local boys made good.

Between 2000 and 2006, Starbucks' China business increased 30% per year and they are just getting started with a little over 400 outlets out of their 12,000 worldwide total. The company plans to have 15,000 international locations in the future and opens more than 1 store per day.

The big knock on Starbucks has been that people won’t keep paying that kind of premium for coffee, but we have seen this year evidence that they will - the company just raised prices with hardly a peep heard from the clients. Gas may be $3.50 a gallon, but Starbucks will still have a record quarter. Frankly, it makes the coffee seem cheaper when it’s less than a gallon of gas!

But can Chinese customers afford that? Yes:

#1 - They pay less than we do. Employees are Starbucks’ largest expense and cheap Chinese labor allows them to sell much cheaper coffee over there. Don’t forget, Starbucks is in the business of exporting coffee; the shops are just bonus money for them.

#2 - It’s cool.
Starbucks is the Al’s Diner (Happy Days) of China. Where the heck else are they gonna go? Heck, we go to Starbucks and we have our own cappuccino machines at home with 60” TVs in our living room and cool stereos and stuff, yet still we go there! China is like Happy Days with very few places for kids to get together so they all commune in the local hangout, which is starting to be Starbucks.

#3 - Friends. On the TV show, those people spent their lives in the coffee shop. Chandler and Joey had money, but Phoebe and Rachel were always broke - yet they could all hang out at the coffee shop all day long. China’s disparate economic classes need a common place to gather and Starbucks fits the bill as it’s cool enough for any yuppie, yet cheap enough for everyone to hang out and spend whatever money they had.

Warren Guo, “a 30-year-old who works in foreign trade,” told the paper that he doesn’t actually like coffee. He comes to Starbucks because there are “many girls.” Runway model Fang Sun Yan “started coming to Starbucks to meet friends.” Now she says she’s grown “a little bit addicted” to coffee and visits “as often as three times a week.” We all have friends who are “a little bit addicted” to Starbucks.

If Starbucks pulls back to $25, I will consider it a gift and load up on Jan ‘10 30 call options, which should fetch around $4.50. I will hold that and sell the short calls for the next couple of years for a very nice income stream. At $5.25, I’d rather buy the ’09 $25s and roll them back later but I can sell the Sept $27.50s for $1.05, not a bad initial return for 50 of my 540 days of ownership.

Starbucks had gone pretty much straight up from $2 in 1996 to $40 in April when they fell out of favor and took a 35% pullback since. That leaves Starbucks trading at it’s 2005 high, although that year the company had $6.4Bn in revenues, making .61 per share while so far in ‘07, in just 2 quarters, the company has $4.6Bn, making .46 per share – that’s outperforming the first half of ’05 by 58%

This pullback is now in its 10th month, the same amount of time as it took to run up from $24 in Sept 2005. I see no reason this stock won’t hit $40 again in the next 10 months but I’m giving it 18, just to be safe!

I will save some time writing another article that would be almost identical by just giving you the title: “All the Diapers in China”. The biggest difference between Wal-Mart and Starbucks is that Wal-Mart ALREADY employs more people than the US Army!