Church of Starbucks: Ahead, Belief Required

With a few ups-and-downs, Starbucks (SBUX) shares essentially marked time in 2014, up just 3% as we write this, after a spectacular 2013 performance that featured a 43% rise in the coffee seller’s stock.

View 2014 as a year of consolidating gains, then, but Starbucks enters 2015 (the fiscal year actually ended September 28) with an audacious growth program that could make current trading levels a nice entry point. Or, if there is failure to execute on an increasingly complex business model, the 2014 pause could be viewed in hindsight as what was an excellent and sustained opportunity to hop off CEO Howard Schultz’s happiness bus.

SBUX Chart

SBUX data by YCharts

Schultz’s twin attributes – grandiose self-regard and weakness for the worst of business clichés, coupled with an amazing rigor and discipline in operating the hot-drinks chain – attach a cult of personality to Starbucks shares, and perhaps a Howard-premium to go with it; the PE ratio based on trailing net income is just shy of 30 right now.

For the love of clichés, sample this buzzword-heavy quote attributed to Chairman Howard (God help his family and friends if the guy actually talks like this; we’ve helpfully italicized the most obvious clichés jammed into his remarks) in Starbucks’ recent announcement of the new five-year plan:

“Over the next five years, Starbucks will continue to lean into this new era by innovating in transformational ways across coffee, tea and retail, elevating our customer and partner experiences, continuing to extend our leadership position in digital and mobile technologies, and unlocking new markets, channels and formats around the world.”

Three decades-plus of covering Corporate America makes me want to guard my wallet when I hear CEOs talk like that. Compare his buzzy language to Warren Buffett’s simple remarks to Berkshire Hathaway (BRK.B) shareholders, for instance. But Schultz has delivered a turnaround, since coming back as CEO, which is truly amazing, turning what was simply an opportunistic growth company into a productivity machine. If he’d only talk like a human, it would be easier to trust what he says. That skepticism, however, delayed my appreciation of what Schultz was accomplishing, so you’re invited to label me a disbelieving crank.

If you’re holding Starbucks shares, or contemplating buying some, however, it would be wise to do some investment research into the means required to achieve Schultz’s goal in the 5-year plan: a near doubling of revenues from the 2014 fiscal year base of $16.4 billion.

SBUX Revenue (TTM) Chart

SBUX Revenue (TTM) data by YCharts

That will require a rate of growth roughly equal to the last five years, and that means overcoming the increasing presence of the law of big numbers. “A remarkable feat for a company that now has nearly 22,000 stores,” notes Sharon Zackfia, an analyst at William Blair & Co., in a recent report.

Comparable store sales the past five years have been remarkable – up between 6% and 8% each year. Zackfia, who rates the stock outperform, notes that the formula for achieving Schultz’s plan assumes continued “midsingle-digit comps, 10%-plus revenue growth, and 15% to 20% EPS growth.”

To get there, Schultz has set difficult-to-achieve goals:

--Mobile ordering by a growing portion of Starbucks clientele, which would enable existing stores to handle lots more business without lines out the door.

--Longer hours at stores to also increase per-store sales, which are about $1.3 million in the U.S. To add $1 billion revenue by 2019.

--More food sales, with food rising to 25% of U.S. retail sales form 18%. To add $4 billion revenue by 2019.

--A slew of cost cutting moves, simultaneously, to reduce expenses by $1 billion a year.

--Adding 8,000 new stores by 2019. Think the U.S. is saturated by Starbucks? The home market would get 3,500 of those new outlets. And throw in more drive-thru locations, some mobile trucks dispensing coffee and an experiment with delivery.

--A huge increase in Starbucks’ China business, where the company, Zackfia says, is opening a new store every 18 hours.

There is plenty more. Suffice to say Schultz is doing what he – and other retail executives should do – which is to seek any and all means to leverage stores and brand power. Zackfia suggests the opposite of saturation: “per capita sales that increase disproportionately with Starbucks’ density in a market.” Starbucks’ rollout of mobile ordering and its customers’ increasing use of Starbucks stored-money (gift) cards are both models for the retail and fast food industries.

What might concern you, however, is the complexity of it all – and some external forces. As we’ve written of late about McDonald’s (MCD), there is a glut of fast food outlets in the U.S., and the supply only seems to grow, as entrepreneurs enter the field and financiers freely support their efforts.

Starbucks is a powerful brand and one tens of millions of consumers are loyal to, for now. But as we’ve seen in the beer business, mass-market success can be curtailed by consumer desire for new and better products. The craft brewing boom forced major brewers to play defense, and ended their period of growth. Coffee fragmentation requires physical stores, a higher hurdle than existed in beer, but the early signs of a booming craft coffee world are all around us.

If Schultz executes well on the five-year plan, even in the early going, the stock could resume its rise. But the path he has set for Starbucks will grow more difficult each year.

Jeff Bailey, The Editor of YCharts, is a former reporter, editor and columnist at the Wall Street Journal and New York Times. He can be reached at editor@ycharts.com. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.

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