Although in certain cities it may seem like there's a Starbucks (SBUX) on every street corner, the fact is that the well known coffee shop still has plenty of opportunity to expand.



Evidence that its business remains in a growth phase and far from maturation can be found in both the company's first quarter results, and management's related comments.

For those that didn't catch the company's earnings release earlier this month, Starbucks turned in a solid quarter, posting 26 cents a share profit, which was essentially in-line with Wall Street estimates.

Drilling down a bit deeper, I found the fact that the company was able to keep its operating margin stable at about 14% of total sales despite increases in rent, payroll and a variety of material costs to be quite impressive.

In addition, the fact that its receivables and inventory levels appear to be growing in parity with its sales is also a good sign that the company is getting paid, and that isn't getting stuck with a slew of outdated merchandise.

(After all, nobody wants to get caught with an extra gross of "Yanni" CDs, and pea-colored Starbucks Coffee mugs on their shelves! Am I right?)

But seriously folks, the company is also doing a number of other things to ensure growth in 2007 and beyond.

For example, it has launched an array of oven-warmed breakfast sandwiches in more than 1,000 of its stores, and it plans to expand those product offerings in the coming year. The pricing on the sandwiches is quite competitive (around $3 each), and although I haven't tried them personally, I've heard that they are downright tasty.

Anyway, if you can't tell, I'm really excited about this breakfast opportunity. That's because breakfast as a meal has largely been overlooked by the fast food industry. Sure there's McDonald's (MCD), Wendy's (WEN), Burger King (BKC), Krispy Kreme (KKD), Tim Hortons (THI), and Dunkin Donuts.

But look at the stuff those guys put out. Topping their menus are hot cakes, sausage, biscuits, and greasy (albeit tasty) doughnuts. But they have little in the way of sandwiches. And I mean good, deli quality sandwiches. Not that mass produced gobbledygook that most of the above-mentioned parties put out.

Long story short, new product introductions such as its line of breakfast sandwiches will help draw foot traffic and drive same-store-sales going forward. In fact, it's already started to pay dividends -- comparable store sales were up an impressive 6% during the quarter.

Another thing that I like about Starbucks is that it's aggressively trying to build out complimentary sales. I mean have you been into a Starbucks lately? There are books, CDs, mugs, bags of coffee and a slew of other knick knacks designed to boost the number of dollars that each consumer spends in its stores.

At present these products make up only about 5% of Starbucks' total revenues. But I think that going forward, their presence will definitely help to drive same-store-sales (and overall sales) growth, as well as serve to enhance the consumer's experience -- a factor that shouldn't be overlooked.

But even beyond its ability to grow sales at its existing stores, I think Starbucks has a fair shot of being able to open thousands of new stores in the coming years without cannibalizing the markets in which they already operate. As things stand right now the company operates more than 13,000 stores worldwide. (This past quarter alone it opened more than 700 locations). And in 2007 management has said that it plans to open as many as 2,400 locations, which would effectively grow its store base by almost 20%.

Over the long haul the company has said that it thinks that it could operate as many as 20,000 locations in the U.S. and at least another 20,000 internationally. The fact is that I think that these numbers are feasible. After all, the company is kicking off some pretty healthy operational cash flow, and it seems to have the financial wherewithal (meaning the cash, management know how, and access to credit lines) to open locations at a fairly rapid clip.

Of course 40,000 is a lot of stores. But again I think it is feasible. As evidence, companies such as Yum! Brands (YUM) (which owns Taco Bell, Pizza Hut, and KFC), and McDonald's operate more than 34,000 and 30,000 restaurants respectively worldwide, yet they are still growing by double digits each year!

Moreover, in many parts of Europe Starbucks is still a relative unknown, meaning that there should still be plenty of room to expand (especially on the international front) without having to worry about revenue cannibalization.




What Could Go Wrong?
In an effort to present both sides of the story I'd be remiss if I failed to mention that with the potential rewards of a rapid growth plan also come risks. While Starbucks is enjoying rapid growth right now (it's expected to grow its earnings at about a 20% clip for the next two years), a slowdown in consumer spending or an economic downturn (particularly in the U.S. market where more than 70% of its geographic footprint is located) would undoubtedly stymie that plan.

Another concern is that fast food players could try to steal some of Starbucks' thunder with competitive coffee products of their own. McDonald's is a perfect example. The well known burger chain has been tinkering with its coffee blends over the past year to try to draw more foot traffic. And while they haven't knocked Starbucks off the coffee throne as yet, they've undoubtedly shored up customer loyalty with their tasty offerings (I can attest to this first hand).

So What is the Stock Worth?
At present Wall Street figures the company will earn $0.89 a share in 2007 and $1.08 a share in 2008. I think that based upon the company's store opening plans and recent same-store-sales trends that these numbers may actually be light by perhaps a nickel each. But in any case, based on 20%+ earnings growth, I think the stock could easily trade north of $40 a share in the coming year, implying a potential upside of about 25%.

The Bottom Line
Over the past few decades Starbucks has grown from a small Seattle-based coffee retailer to a global chain with roughly $7 billion in annualized revenue. But in spite of its meteoric rise in popularity and vast geographic footprint, I think that the company has the ability to continue to show accelerated growth in the future. Again, as I mentioned above, I think we are looking at a $40 stock here within a year's time.



Filed Under:
Tickers in this Article: SBUX, MCD, WEN, BKC, KKD, THI, YUM

comments powered by Disqus

Trading Center