Company Spotlight: Starbucks Corporation

[Pages:7]Company Spotlight

MarketWatch: Drinks

Company Spotlight: Starbucks Corporation

Starbucks Corporation, the world's leading coffee shop chain, is brewing plans to double its store number in the US, where it currently operates 8,614 outlets.

Speaking at an interview in New York, the Seattle-based coffee giant's chairman, Howard Schultz, said: "[T]he saturation opportunity in the US is not 50% there."

Shultz said the group has a target of operating 30,000 stores internationally; it currently operates over 12,000 stores across 37 countries, with 70% located in the US.

The coffee maker, which recorded its lowest sales growth in four years during the July-August period, added 1,672 stores to its portfolio last year in an effort to boost profits and attract new customers.

The group is also looking to boost store numbers in under-represented areas where demand is on the increase. Areas of interest include parts of the US and the growing markets of China, Taiwan and India. Around a quarter of new Starbucks stores this year are being built outside the US.

In 2007, Starbucks is hoping to add 2,400 new stores globally, which is the equivalent of about six stores a day.

Business Description

Starbucks Corporation specializes in the sale of coffee and other beverages at more than 10,241 stores operated and licensed in the US and approximately 37 countries across the globe. The company operates in three divisions: company operated retail stores, specialty licensing and foodservice and other.

Starbucks' company operated retail stores are located in high-traffic, high-visibility locations. It operates approximately 6000 stores in this division including 1100 drive-thru locations.

The company's specialty operations strive to develop the Starbucks brand outside the company-operated retail store environment through a number of channels. These relationships take various forms, including licensing arrangements, foodservice accounts and other initiatives related to the company's core businesses. In certain situations, Starbucks has an equity ownership interest in licensee operations. As part of these arrangements, Starbucks receives license fees and royalties and sells coffee, tea, compact discs and related products for resale in licensed locations. The company operates about 2435 licensed stores.

In the foodservice and other division, the company sells whole bean and ground coffees, including the Starbucks, Seattle's Best Coffee and Torrefazione Italia brands, as well as a selection of Tazo teas to institutional foodservice companies that service business, industry, education and healthcare accounts, office coffee distributors, hotels, restaurants, airlines and other retailers. The company's total worldwide foodservice operations had approximately 15,500 accounts at fiscal year end 2005. This division also includes the company's emerging entertainment business, which encompasses multiple music and technology based initiatives and partnerships with other music labels. Among these initiatives are strategic marketing and cobranding arrangements, such as the 24-hour Starbucks Hear Music digital music channel 75 available to all XM Satellite Radio subscribers, and the availability of wireless broadband internet service in company-operated retail stores located in the US and Canada.

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Key Facts

Address

Website Telephone Fax

Turnover Employees Financial Year End Ticker Stock Exchange

2401 Utah Avenue South Seattle WA 98134 USA

1 206 447 1575 1 206 447 0828

$6,369 million 115,000 September SBUX NASDAQ

Major Products Include:

Brewed coffees Cold blended beverages Tea products Fruit juice Sodas Sandwiches Salads Pastries Ice creams Mugs Coffeemakers Compact discs Games Books

Revenue Analysis The company recorded revenues of $6369.3 million during the fiscal year ended October 2005, an increase of 20.3% over 2004. US, the company's largest geographical market, accounted for 83.8% of total revenues.

Starbucks Corporation generates revenues through its three business divisions: company-operated retail (84.7% of total revenue during fiscal year 2005), specialty licensing (10.6%) and foodservice and other (4.8%).

Revenues by Division

During the fiscal year 2005, the company-operated retail division recorded revenues of $5391.9 million, an increase of 21% over 2004.

The specialty licensing division recorded revenues of $673 million in fiscal year 2005, an increase of 18.9% over 2004.

The foodservice and other division recorded revenues of $304.4 million in fiscal year 2005, an increase of 12.3% over 2004.

Revenues by Geography

US, Starbucks' largest geographical market, accounted for 83.8% of the total revenues in the fiscal year 2005. Revenues from the US reached $5334.5 million in 2005, an increase of 18.8% over 2004.

International accounted for 16.2% of the total revenues in the fiscal year 2005. Revenues from international markets reached $1034.8 million in 2005, an increase of 28.8% over 2004.

SWOT Analysis

Starbucks Corporation (Starbucks) is a specialty coffee retailer, producing and selling a wide variety of hot and cold beverages, pastries and confections through over 10,000 locations across 37 countries. The company leverages its strong brand image to increase its bargaining power and differentiate its offerings. However, intense competition in the retail beverage segment could adversely affect the company's profit margins.

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Table: SWOT Analysis Strengths

Brand image Strong financials Steady cash flows Opportunities Entry into new markets New stores Growth in coffee market

Source: Datamonitor

Weaknesses Reliance on US market Narrow product mix Low revenue per employee Threats Intense competition Volatile coffee markets Expected slow down in the US economy

Strengths

Brand image

Starbucks has built an excellent global reputation based on the quality of its products and for its delivery of a consistently positive consumer experience. The Starbucks brand has been highly rated in several global brand value studies and in 2005 Interbrand valued the Starbucks name at $2,500 million. Starbucks uses innovative and cost effective marketing strategies to build its image including billboards, freestanding inserts in newspapers products and samplings, as well as innovative schemes such as paying for a day of free parking in a downtown area. The Starbucks brand fosters a sense of shared experience, and this strong image has helped the company in increasing customer awareness and acceptance of its products and services.

Strong financials

Starbucks has reported consistent revenue growth over the last five years. During 2002-2005, the company reported a 24.6% CAGR in revenues, totaling $6,369.3 million in 2005. The operating margin of the company improved from 11.5% in 2004 to 12.3% in 2005. Moreover, the company's average return on equity during 20012005 was 16.6%, against industry average of 14.7%. Its return on investment for the same period was 20.3%, significantly higher than the industry average of 9.3%. For the same five year period, it reported a 12.1% return on average assets as compared to an industry average of just 8.8%. A strong financial performance by Starbucks has boosted investor confidence and helps the company carry out its plans for growth.

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Steady cash flows

The company has recorded strong cash flow from operating activities. During 2002-2005, the company's cash flow from operating activities reached a CAGR of 23%. The company's free cash flow in absolute terms was approximately $250 million in fiscal year 2005, and is expected to increase significantly in 2006. This strong cash position helps the company to expand aggressively in international markets.

Weaknesses

Reliance on US market

Starbucks derived 83.7% of its total revenues from the US market in 2005. Given that the company is an international brand with wide ranging operations in more than 30 countries, it should be looking to generate a greater proportion of revenues from outside the US. Its reliance on one single market exposes the company to the risks associated with operating in that market. The company's focus on dominating the lucrative US market may impact its ability to sucessfully diversify its geographical base.

Narrow product mix

The company's retail sales mix by product type is roughly 77% beverages, 15% food items, 4% whole bean coffees, and 4% coffee making equipment and other merchandise. The company's sales growth has been largely driven by beverage innovation which may not be sustainable in the long term. As a result, the company's valuation may not match that of its competitors. A diminishing return from beverage innovation, one of the company's competitive strengths, would have an adverse effect on the company's performance.

Low revenue per employee

The company generates lower revenues and income per employee compared to the industry average. Its revenue per employee was $55,385 during fiscal 2005; the industry average was $120,464. Diedrich Coffee, a competitor of Starbucks reported $104,166 revenue per employee during the same period. Furthermore Starbucks' net income per employee is just $4,300, compared to the industry average of $8,578. Diedrich Coffee, on the other hand reported $29,007.9 of net income per employee. The company's lower return per employee in comparison to the industry average reflects poorly on its internal processes, and may indicate an unnecessarily complex management structure.

Opportunities

Entry into new markets

As part of its strategy to increase its worldwide presence, Starbucks has recently opened stores in several new countries, including (in 2005) Jordan, the Bahamas and the Republic of Ireland. In fiscal 2006, the company plans to enter the ready-to-drink coffee category in South Korea through a licensing agreement with Dong Suh Foods; the Korean firm will import US-produced bottled Starbucks Frappuccino coffee drinks into its native country. Additionally, Starbucks plans to enter selected markets in other developing countries such as Russia and Brazil. These new markets present the company with significant growth potential and, if successfully exploited, would help the company diversify its revenue base.

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New stores

Starbucks opened 735 new company-operated stores during fiscal year 2005. In the same year, it increased its total of stores in China to more than 200. This means Starbucks now has (including company operated retail stores and licensed stores) increased total locations from 8569 in 2004 to 10,241 in 2005. This 19.5% increase in the number of stores is in sync with Starbucks strategy for expanding its retail business by increasing its market share in existing markets and opening stores in new markets to increase global market share, and so increase top line revenues.

Growth in coffee market

The specialty coffee sector accounts for roughly 15% of the US retail coffee market. The market experienced 157% growth in value terms between 2000 ($3,258 million) and 2005, to reach $8,372 million in total. This tremendous growth was driven by the enormous appetite Americans have shown for up-market and premiumpriced coffees. Over the next five years, sales are expected to grow by a further 125% to reach an impressive $18,839 million by 2010. Starbucks has a market share of over 40% of the specialty coffee market, and the anticipated growth in this category will offer the company considerable opportunities for further growth and expansion in the near future.

Threats

Intense competition

Starbucks faces intense competition in coffee beverage sales from other specialty coffee shops, restaurants, and doughnut shops. In almost all markets in which the company conducts business there are numerous competitors in the specialty coffee beverage business. The company's whole bean coffees compete directly with specialty coffees sold through supermarkets, specialty retailers and a growing number of boutique specialty coffee stores. In addition, regional specialty coffee companies also sell whole bean coffees in supermarkets. Increasing competition may adversely affect the company's top line revenues and threaten its market share.

Volatile coffee markets

The supply and price of coffee is subject to a high level of volatility. The company's quality requirements for standard coffee exposes it to multiple risk factors in the producing countries, including weather, political and economic conditions which may adversely affect the company's business. Green coffee prices have, in the past, been affected by the actions of organizations and associations attempting to influence the price of green coffee through agreements establishing export quotas or restrictions on global coffee supplies. The actions of these associations could cause a significant degree of disruption to Starbuck's operations. Coffee is the company's largest input cost, accounting for between 10 and 20% of the cost of goods sold. During the first few months of fiscal year 2005, commodity coffee prices increased significantly. They are expected to increase further, by at least 10%, in 2006. Any significant increase in the market price or any significant decrease in the availability of high quality coffee is likely to adversely affect the company's business and net financial results.

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Expected slow down in the US economy

The US, far and away Starbucks' largest geographical market, has seen 16 successive interest rate hikes over the past few years leading to the current high of 5%. Inflation fears in the US may see yet another raise in the short-term. US consumer spending is expected to slow down, as consumers tighten belts in reaction to rising interest rates and the threat of inflation. Real GDP growth is forecast to slow from 3.5% in 2005 to 2.8% in 2006 and 2.5% in 2007. Rising interest rates are already beginning to depress consumer spending, as the percentage of disposable income that US households pay out to service mortgage and consumer debt is increasing. This could adversely affect the revenues of Starbucks.

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