Watery Coffee: Starbucks Can Get Growth in China, But What About Margins?

Starbucks (SBUX) plans to triple its presence in China over the next three years, following McDonald’s (MCD) and YUM! Brands (YUM) as domestic markets start to saturate.

The move shows Starbucks’ need to keep revenue growth moving if it hopes to maintain a relatively lofty valuation. Starbucks’ PE is well above McDonald’s PE and YUM’s PE.

SBUX PE Ratio Chart

SBUX PE Ratio data by YCharts

The higher valuation comes despite revenue growth that doesn’t stand out all that much from McDonald’s and YUM.

SBUX Revenue Growth Chart

SBUX Revenue Growth data by YCharts

Another worry: to date Starbucks’ margins overseas have been far narrower than its domestic margins.

Overseas expansion is tough. Sure, all the CEOs of big multi-national companies like to consider themselves – and their companies – global players. But the long-term truth has been that companies entering foreign markets often fail to achieve profitability levels they enjoy at home. As global as their outlook might be, they’re still outsiders and often late to a market. Sometimes, of course, companies merely need to reach critical mass in foreign markets. But often, there are more serious impediments to lush margins abroad.

Wal-Mart (WMT), for instance, is getting all its growth from international operations, but its margins abroad are crummy compared to those in the U.S.

McDonald’s and YUM have been in China for years. YUM’s KFC is head and shoulders above the competition with 3,701 stores versus McDonald’s 1,500.

YUM’s 4,500 KFC and Pizza Hut stores in China have an operating margin of 16%, a little weaker than its 20% margins for its international division, which excludes China, and about even with that of its U.S. business.

For YUM, same-store sales in fiscal 2011, which ended Dec. 31, jumped 19% in China versus a 1% drop in the U.S. Bloomberg BusinessWeek explains how YUM’s KFC managed to become a great brand in China while deterioraring in the U.S, a rare occurrence.

McDonald’s doesn’t break out margins in China. Its divison encompassing Asia, the Pacific, Middle East and Africa has lower operating margins for company-owned stores than in the U.S. – 17.3% vs. 20.6%. McDonald’s presence in China is largely through company-owned stores.

Starbucks already has about 500 stores in China, and plans to have 1,500 by 2015, the Wall Street Journal reported.

Starbucks’ 19.4% operating margin in the U.S. in fiscal 2011, ended October 2, puts to shame the 13.3% from international operations. Starbucks does not break out its China business separately.

Michael McHugh is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings, stock screener and portfolio strategies.



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