Under the Spotlight | Starbucks Corporation (SBUX)

ref: Stake newsletter on 2021-10-23

As the centre of western culture and capitalism, the States are known for a few things. Coffee isn’t one of them. Still, Starbucks has taken over the country as it revolutionised how consumers drink coffee. Instead of the dollar-cup of watered-down brew found on diner counters countrywide, coffee is now a premium, customisable product. With 50 years of history, Starbucks is now part of the daily lives of millions of people around the world, but it wasn't always like this.

Founded in Seattle in 1971, Starbucks emerged to sell premium coffee beans to baristas and coffee aficionados in Washington's capital. The Starbucks we know today was very different to this B2B business. What boosted the company to success was the sale of the company in the 1980s to businessman Howard Schultz, who decided to change not only the business model, with the opening of franchises, but also the main product. From beans to the finished product itself. This change caused the business to expand to the point that eventually the green mermaid would earn a spot on desks, offices and lecture halls across the world.

While coffee shops have relatively attractive margins, selling such low-value products means volume is king. Starbucks' gross margin is 28.15%. Unfortunately for them, that’s only a couple of dollars per order. Moreover, the barrier to entry in the industry is extremely low, after all, anyone can set up a coffee shop.

For this reason, acquisitions were fundamental for the company's growth. One of the most successful items on the cafe’s menu, the Frappuccino, came precisely from the acquisition of Coffee Connection, in 1994. The drink is a mixture of a frappé (smoothed milk, but in French and, therefore, more expensive) with a cappuccino, resulting in something that looks like a milkshake, that can be made with or without coffee, in addition to having a little less orthodox base options, such as strawberry flavour, for example, one of the company's best sellers.

Today, with more than 32,000 stores and around 350,000 employees across the planet, the strategy of acquiring key competitors was unquestionably a success for the company, which expects to earn US$29 billion in 2021. However, the company will face huge challenges to continue to expand globally.

CROSSING BORDERS

Even if the acquisitions strategy was very successful in the American market, it might be difficult to replicate in other countries. This is especially true in emerging countries, which have a very diverse market, without major players dominating the sector running large chains in several cities. Look at Australia, everyone’s favourite coffee shop is independent. Growth in other countries is essential for the company's expansion plans to succeed.

The United States is obviously Starbuck’s major revenue source, with the largest number of stores, followed by China, Canada and the United Kingdom. However, if the US is today the largest coffee shop market, it doesn't seem to offer much opportunity for growth: in 2020, the balance of new stores opened in the country was zero, while other countries inaugurated more than 1,150 new establishments, even in a tough year, with stores closed due to the Covid-19 pandemic.

Even though it’s growing, the international market is still not very representative for the company, accounting for just US$6.6 billion of last year's revenue, which was US$23.5 billion. Interestingly, outside the US, Starbucks has a higher percentage of franchised stores, which dilutes operational risk and ensures greater predictability of revenues. The number of franchised stores is still very small, however, accounting for only 16% of the company's revenue, while in the case of other giants in the food sector, such as McDonald's, this number reaches 93%.

TIGHT BELT

In 2008 Starbucks began offering a “skinny” product line, with low-calorie, sugar-free drinks. But in addition to trying to keep its customers slim, the company is committed to not letting something else grow: it’s costs. Since 2016, the company's operating cost is around US$3.8 billion per year, reaching US$3.9 billion only in 2021, a growth of just over 2%. In real terms, that is, if we consider the period's inflation, the value is negative.

Keeping costs in line with revenues growing about 10% annually is an explosive combination, causing the company's stock to more than double in the past five years. Low spending growth also enabled the company to survive the Covid-19 pandemic, even though it closed many of its stores due to lockdowns around the world.

By the end of 2021, the company's revenue and cash flows are expected to reach record levels again, following the reopening of global economies as people leave home looking for exactly what made Starbucks famous in the US: cozy environments and premium coffee to follow a good conversation.