Starbucks Growth Is Increasingly About China

| About: Starbucks Corporation (SBUX)
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Starbucks (NASDAQ:SBUX) has indicated that China will be its largest market outside the United States by 2014.

On Thursday Starbucks announced that its profit rose 13% for the quarter ended December 31st, the first quarter of its fiscal year. The company also indicated that comparable stores sales increased 7% for stores in the U.S. and 6% for stores globally, for the three month period.

Starbucks' net income for the quarter was $432 million, corresponding to $.57 per share, up from $382 million or $.50 per share for the same quarter of 2011. Revenues in the quarter increased 11 percent, to $3.8 billion.

While the announcement didn't provide specifics regarding its growth in China, the company indicated that its comparable store sales grew 11% in what it refers to as its China/Asia Pacific region. The company stated that its net revenues in the region were $214.1 million, an impressive 28% increase over the same quarter of last year. The revenue increase was due to incremental additional revenues from 166 net new company-operated store openings over the past 12 months. It was also the result of an 11% increase in comparable store sales. Starbucks' revenue growth in the China/Asia Pacific region from licensed stores was 14%, which the company indicated was a major contributor to its regional growth.

Starbucks' shares closed Friday at $56.81, up $2.24 or 4.1%. The company's shares are trading at a P/E of 30.56.

Starbucks growth of revenues and income in China are in sharp contrast to the recent problems that have been facing Yum Brands (NYSE:YUM) with its KFC operations in China. Yum Brands has been one of the pioneers of localization in China, tailoring its business operations and menus to local tastes. But, the company has recently been struggling in China.

Yum Brands indicated earlier this month that its fourth quarter same story sales for its China division same store sales fell 6%. The company attributed this decline primarily to negative publicity regarding the quality of the company's chicken supply. The company faced Chinese regulatory scrutiny by the Shanghai Food and Drug Administration as to whether the company had purchased raw chicken from two suppliers with higher than permitted levels of antibiotics. Yum earned more than 44% of its global revenues in China last year, and the negative publicly significantly hurt the company's image in China and impacted its global revenues and financial results.

The Importance of China to Starbucks Growth Strategy

Starbucks began its business operations in China in 1999. Since that time, China has been increasingly important to Starbucks global growth strategy. Starbucks now has approximately 18,000 stores in 61 countries, and has indicated its intent to have 1500 stores in China by 2015.

As of September, 2012 Starbucks' stores in China averaged $886,000 in annual sales, up from $507,000 in 2008. The company expects China to become its largest market outside the U.S. in 2014.

In November the company indicated that it had approximately 12,000 employees in China, a number that it expects to grow to 30,000 over the next three years. The company has stated that it sees the potential for thousands of its cafes in China, and with the number of its cafes in China reaching 1,500 by 2015.

Starbucks' loyalty program is proving very beneficial for the company in China. The company stated that it has three times the penetration of members per store than it does for stores in the United States.

The turnaround in China's economy has also been positive for Starbucks. the country's fourth quarter economic output increased 7.9%, compared to the same quarter of 2011. Louis Kuijis, the China economist at the Bank of Scotland commenting on the country's economic growth indicated that he has increased his growth forecast for the country for 2013 from 8% to 8.4%. While this growth rate is down significantly from the country's 9.3% growth rate in 2011, when one compares it to the growth rate of the rest of the world, it is significant.

Also importance for China's future in China are the government's efforts to transform the country's economy. Since the global economic crisis of 2008, China has been trying to move the country's economy away from one that has been primarily dependent on exports, to one that is more consumer based. This governmental objective, which is a major structural shift has begun and while likely to occur gradually, is positive for Starbucks' future in the country.

According to the Boston Consulting Group, the number of affluent consumers in China is expected to reach 280 million by 2020, more than double the current 120 million. Since the global financial crisis of 2008, and with it the reduction in consumption from primarily Europe and to some extent the United States, China has been trying to encourage its population to spend more.

The Boston Consulting Group report indicated that most of China's current affluent consumers are under 45 years of age, and had arrived at their affluent consumer status after having been in the country's middle class for at least five years. The report also indicated that these affluent consumers were placing more emphasis on emotional satisfaction with purchases, and less on utility. These factors are and will continue to be factors that will contributor to Starbucks' strong growth in China. The report also indicated that 75% of future affluent consumers would live in what are commonly referred to as smaller-tier cities in China. This is also beneficial for Starbucks as the company proceeds with its plans to open stores in smaller Chinese cities. But Starbucks has indicated that its facing a challenge in dealing with the complexities of operating in a country where consumers in second tier cities are just getting their first Starbucks cafe.

A key aspect of Starbucks' strategy in China is for the company's operations to become more Chinese. This strategy has resulted in a larger cafe size, some that are nearly 3,800 square feet. With many Chinese valuing space, Starbucks has indicated that it is seeking to tailor its stores to provide an environment where customers can meet groups of friends and business colleagues, and have couches to relax on.

While China remains a tea drinking culture, Euromonitor International has indicated that in 2011 coffee sales in China increased 20% to almost $1 billion, which is significant for Starbucks. The company's China strategy has also resulted in the company introducing locally inspired flavors, including building a family of drinks based on a favorite drink, its red bean frappuccino. The company has also altered its selection of sandwiches to cater to local tastes, including Hainan chicken sandwiches, rice wraps and Thai-style prawn wraps.

John Culver, the president of Starbucks China and Asia-Pacific at an investor conference in December stated:

"Thirteen years ago, the core Chinese consumer didn't have an appreciation for high-end coffee. They also didn't have a place to come with their friends and families. Fast forward 13 years and our core customers are local Chinese and they love our espresso beverages. These are the very early days of our growth in China."

Confirming the importance of the company's China strategy, Howard Schultz, the company's CEO stated on the company's first quarter earnings conference call:

"Starbucks' China and Asia-Pacific segment now spans 12 countries, that by the end of fiscal 2013 will grow to nearly 4,000 stores, including 1,000 stores in Japan and 500 in Korea. China-Asia Pacific continued to deliver in Q1, with a strong 11% increase in comp store sales marking our 12th consecutive quarter of double digit comps in that region.

We started our journey in China with our first store in Beijing in 1999, and in Q1 we celebrated the opening of our 100th store in that extraordinary city. China remains Starbucks' most significant market opportunity in this region, and is well on its way to becoming our second-largest global market in 2014. Today we are proud to operate over 700 stores in mainland China, and we are on plan to have 1,500 Starbucks stores in over 70 cities across China in 2015."


Starbucks is definitely is worthy of investor consideration, if for no other reason than its strong presence in China, as well as its commitment to the country as a key linchpin of its global growth strategy. It's also likely that revenues and income from the company's China operations will increasingly become more important for Starbucks.

If Yum Brands can turn around what can be best described as a public relations debacle, and return to growth of its same store revenues in China, it may be worthy, once again, of investor consideration.

Starbucks is joining a list of global and Chinese companies that I believe are worthy of investor consideration. These include:

  1. Sutor Technology Group (SUTR) manufactures and distributes finished steel products and welded steel pipes. I've discussed this company previously here at Seeking Alpha. For the three months ended September 30th, the company's revenues were $117.2 million, and its net income was $1.8 million. But what is significant to me is that the company remained profitable for the quarter, a quarter that was a tough operating quarter for many companies with Chinese operations. The company hasn't released its fourth quarter results 2012 results, but I wouldn't be surprised if the company's revenues and net income will both have substantially increased. The company's current P/E is 4.63.
  2. China Industrial Steel Inc. (OTCPK:CDNN) produces and sells steel billet, steel plate, and steel bar. The company's products are primarily used by the construction industry and in large scale infrastructure projects, including roads and bridges. The company's steel plate is also utilized by ship builders and for pipelines. As I've discussed here at Seeking Alpha, the company could be considered to be an "orphan stock." The company is well positioned to grow as the Chinese economy grows. It's also likely that more investors will start to have the company on their radar screens. China Industrial Steel's revenues for the first nine months of 2012 were $475 million, with a net income of $2.8 million. As I've also indicated here at Seeking Alpha, while a bit speculative, I believe it's likely that the company could return to, or exceed its 2011 revenues of $823 million and net income of $45.8 million. Its current P/E is 4.62.
  3. Asia Carbon Industries (OTCPK:ACRB) was also an orphan stock when I started writing about it here at Seeking Alpha in September. The company is one of the top ten carbon black producers in Shanxi province, China's highest coal producing province. With the rubber industry utilizing almost 90% of the worldwide output of carbon black, most of Asia Carbon's revenues and growth are tied to China's tire industry, and therefore directly to China's growing auto industry, the world's largest. The company's revenues for the three months ended September 30, 2012 increased 15% to $12,699,296, its gross profit increased to $2,700,188, and its net income increased 11% to $1,697,915. Despite the company's strong financial performance, the company is for the most part unknown and undiscovered by investors. The company's shares recently reached a recent high of $.32, up from $.13 a few weeks ago. Asia Carbon's current P/E is 1.54.


Investing in smaller-capitalization companies, as well as investing in companies in emerging markets, including China, is not suitable for all investors, and can be risky. It's important that investors thoroughly perform their own due diligence and analyze the potential risk.

The companies discussed above include major global companies including Starbucks and Yum Brands . It also includes smaller capitalization companies with Chinese operations, whose shares trade in the U.S. But all the companies are U.S. reporting issuers, and subject to the reporting requirements of the U.S. Securities and Exchange Commission, so U.S. transparency and disclosure is available to investors.

Disclosure: I am long OTCPK:ACRB, OTCPK:CDNN. 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.