Analysis: Starbucks CEO bets on multiple growth drivers

LOS ANGELES Tue Jul 20, 2010 3:13pm EDT

A Starbucks drink is seen on a table in New York's Times Square April 21, 2010. REUTERS/Shannon Stapleton

A Starbucks drink is seen on a table in New York's Times Square April 21, 2010.

Credit: Reuters/Shannon Stapleton

LOS ANGELES (Reuters) - Starbucks Corp's (SBUX.O) founder Howard Schultz is moving far outside the confines of his coffee houses to grow a diversified, global business.

Business at Starbucks' namesake cafes has firmed and early signs suggest that the world's biggest cafe chain is making progress with Via instant brew and Seattle's Best Coffee, which are expanding the company's reach in supermarkets and beyond.

Investors will be keen for an update on their potential for becoming billion-dollar ventures when the company reports results on Wednesday.

"The company is transitioning to a portfolio company versus a single-brand growth story," Piper Jaffray analyst Nicole Miller Regan said.

Schultz, who slashed costs, closed hundreds of stores and tightened operations when he returned in early 2008 to lead a sweeping U.S. reorganization, projected confidence and ease in a recent interview in his Seattle office.

"Things are much better than they were ... We are further ahead than I thought we would be at this time, given where we were," the Starbucks chief executive said.

Schultz believes the company has broken a historical correlation between downturns in consumer confidence and slowing sales, as cafe patrons were once quick to give up little luxuries like cappuccino when money was tight.

"We now have created separation for the first time," he said, an event that was helped by a wider range of pricing and a renewed focus on quality. Starbucks is also "very close to pre-recession numbers in terms of comp store sales, traffic and the economics of our store base."

The company hasn't said when Via and Seattle's Best will hit their billion-dollar sales targets and their growth is not yet reflected in the company's stock, which was up almost 11 percent year-to-date through Monday versus an 11.5 percent gain in the Dow Jones U.S. Restaurant and Bars index .DJUSRU.

Analysts' average price target for Starbucks is $29.88, according to Starmine. In afternoon trading, the stock was down 0.2 percent at $25.45.

Via, which has its greatest potential overseas, is on track to turn in $100 million in first-year sales.

Frappuccino, widely viewed as Starbucks' most successful consumer launch with more than $2 billion in annual revenue, took three years -- adjusted for inflation -- to achieve similar sales, said the company, which added that fewer than 3 percent of new consumer products typically hit $50 million in sales in their debut year.

Seattle's Best has been chosen as the morning brew at fast-food chains Subway and Burger King Holdings Inc BKC.N and the brand just opened its first franchised cafe in New York City.

PROFIT GROWTH

Starbucks, which was among the first to show signs of distress when the U.S. housing bubble burst, is expected to report on Wednesday a profit increase of 20 percent for its fiscal third quarter ended in June.

Year-over-year increases in store visits and in sales at established restaurants -- a key gauge of retail health also called comparable store sales -- are expected to have fueled that growth.

Analysts also see some potential upside to Wall Street's average target for quarterly profit of 29 cents a share excluding items, according to Starmine's SmartEstimate, which places more weight on recent forecasts by top-rated analysts. Options investors also are making bullish bets.

Schultz, an avid cyclist who regularly downs doppio macchiatos, told Reuters the coffee chain will post its second quarter in a row of increased foot traffic when it issues its financial report card for the June period.

Starbucks' traffic was up 3 percent overall for the three-month period ended March, ending more than three years of quarterly declines.

Analysts are looking for a roughly 6 percent rise in same-store sales, versus a 5 percent decline in the year-earlier period and a 7 percent rise in the second quarter of 2010.

While stock markets around the world have had a wild ride due to still high U.S. unemployment, jitters over Europe's debt crisis and signs that China's growth is slowing, Schultz said Starbucks' customers for the most part have not retreated.

INTERNATIONAL CAFES

The restructuring in the United States, which contributes more than half of Starbucks' profit, thus far has been the biggest driver of the company's improved results.

The chain is making similar changes in its international markets, where margins have lagged because fixed costs in more than 50 countries are offset by sales from fewer than 6,000 cafes. The United States, by comparison, has more than 11,000.

This fiscal year ending September 2010, Starbucks plans to add 100 new U.S. restaurants and 200 international cafes.

Analysts said progress on the international front initially will be measured by the pace at which Starbucks can open new cafes, and any uptick in international margins will be cheered.

To that end, J.P. Morgan analyst John Ivankoe said in a recent note that he expects Starbucks to nearly double its international growth target to 390 new units for fiscal 2011.

Amid competition from fast-food chain McDonald's Corp (MCD.N), Starbucks has emphasized its premium position with new products and store renovations that add a traditional coffee house feel, with more dark woods and less stainless steel.

Beyond that, Schultz said Starbucks has begun to use its popular cafes and social media prowess, as well as its growing supermarket presence and direct connections with legions of Starbucks card users, to boost business.

The resulting loop, Schultz said, puts the company in a position to create a new kind of business model.

"You can see the beginning of something nobody else has done," Schultz said.

(Reporting by Lisa Baertlein; Editing by Michele Gershberg and Gerald E. McCormick)

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