The dollar index has reached a high of 102 in the last month. This is its highest level in over a decade and is partly due to the prospect of a more hawkish Federal Reserve operating under a Trump Presidency. His plans to reduce taxes and increase public spending could lead to inflation, which may warrant a higher interest rate. In fact, interest rates are forecast to rise to 2.25% in the next three years, which could strengthen the dollar even further.
For companies such as Starbucks (NASDAQ: SBUX) which have major (and rapidly increasing) international exposure, a stronger dollar could mean a squeeze on sales, margins and profitability. While this is a risk for the business over the medium term, I'm still bullish about Starbucks's prospects. I believe that the scale of its growth opportunity in emerging markets, its resilience in the domestic market, improving customer loyalty and greater use of technology will more than offset negative currency translation moving forward.
Emerging market potential
In its most recent quarter, Starbucks announced the opening of its first stores in emerging market economies such as Cambodia, Kazakhstan and Slovakia. This provides the company with a significant growth opportunity in my view, since rising wealth and disposable incomes mean that consumer goods spending is set to increase by 3.6% across the emerging world in 2016.
However, Starbucks' biggest opportunity in the emerging world continues to be in larger emerging economies such as China and India, where consumer goods growth is forecast to be 9.5% and 7% respectively in 2016. In China, Starbucks' strategy to open 500 new stores per annum over the next four years has the potential to dramatically improve its financial performance. Further, the growth rate in sales of consumer goods is expected to be around 7% over the next four years. This should provide a tailwind to Starbucks' newly opened stores.
Similarly, in India Starbucks is in the process of increasing the size of its estate, while also attempting to gain exposure to the lucrative tea market. It has partnered with Tata Beverages in a joint venture which will see its Teavana products sold in over 80 tea shops across India. This is part of a wider push which will see the company attempt to gain a share of the Asia tea market and seek to generate $3 billion per annum in sales in the next five years. With China's tea market being worth $9.5 billion per annum alone, this pivot towards tea in Asia could prove to be a sound strategic move in my view.
Scope for a rise in the size of Starbucks' estate in the domestic market is clearly lower than in emerging markets. The US is a more saturated market, but still offers the opportunity for Starbucks to improve its pricing power. This could help it to record higher sales and margins moving forward.
One way that Starbucks is seeking to boost its pricing power in the US is through an improved customer experience. Starbucks has adopted technology to a greater extent than many of its main rivals, with the use of mobile ordering becoming increasingly popular. In fact, the proportion of Starbucks's sales which were derived from the mobile app increased from 5% to 6% in the most recent quarter.
A mobile app not only improves customer convenience, it also helps to differentiate Starbucks from the competition. Dovetailing with this is Starbucks's increasingly popular customer loyalty programme. Numbers enrolled in the programme increased by 18% in Q3 and there are now over 12 million active members in the US and Canada. The loyalty programme should help to boost Starbucks's pricing power moving forward, with it also providing the company with data on shopping habits and the take-up of new products. This could help the company to decide where to locate new stores, as well as provide guidance on which products are working well with different demographics. It could lead to a more efficient business with higher sales and margins in the domestic market.
As well as growth opportunities in the US and in emerging economies, Starbucks offers a relatively resilient and stable business model. Coffee is more akin to a consumer staple than a consumer good, and so is less likely to be impacted by the potential for a restaurant recession than other food and beverage outlets.
Further, Starbucks has wide geographical diversity, which reduces its risk profile yet further. Given the likelihood of increased uncertainty in 2017 in both an economic and political sense from higher interest rates and a new administration, Starbucks' robust business could become more popular among increasingly risk averse investors in my view.
Certainly, Starbucks' sales and profitability are likely to be affected by a stronger US dollar. With non-US sales accounting for around 20% (and rising) of Starbucks's total sales, the six rises in interest rates which are forecast over the next three years could lead to negative pressure on the company's top and bottom lines.
However, in my view, Starbucks has a major growth opportunity in China, India and the emerging world which outweighs the risks of negative currency effects. Further, its opportunity to develop increased pricing power through product differentiation and higher levels of customer loyalty should positively catalyse its domestic growth. And its relatively stable business model and geographical diversity could appeal if uncertainty rises among investors in 2017. As such, I'm bullish on Starbucks in the long run despite the risks posed by a stronger dollar.
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Disclosure: I/we 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.