Starbucks Corporation (NASDAQ:SBUX) is set to achieve the high end of management's mid-single-digit comp outlook for the foreseeable future driven by an enhanced food offering.
The company, which reported global comparable store sales growth of 8 percent for its third quarter, sees further opportunity around beverage innovation and limited time offers (LTOs). Food is already gaining traction as it contributed 200 basis points to the third quarter's comps (before any real benefit from LaBoulange), driven by breakfast sandwiches, paninis, and lunch boxes.
Food is currently 19 percent of the sales mix in US stores and 19 percent globally. Ultimately, management feels that a goal of a 25 percent plus food mix in the US is not unreasonable.
Starbucks partnered with La Boulange (LB) and the LB food program is not only beneficial for sales but also could have material cost benefits in areas of food waste and supply chain.
"The current food attachment rate is ~one-third of transactions. LaBoulange is initially targeted to improve the current bakery offering, which accounts for ~50% of food sales in US stores," BMO Capital Markets analyst Phillip Juhan said in a note to clients.
LaBoulange is in more than 1,000 stores today, and that number should approach about 3,000 stores by year-end, which is ahead of the initial plan to reach 2,500 stores this year.
As the first wave of LB rolls out over the next 12 months, this line-up will replace the current bakery offering in Starbucks' US retail stores. Bakery represents about half of total food sales while food in total represents 19 percent of retail store sales. This suggests that the initial LB bakery roll-out will impact about 10 percent of the sales mix.
Starbucks is encouraged by the early LaBoulange results. Management is seeing a higher food attachment rate in stores with the LaBoulange offering. Moreover, the LaBoulange product line carries roughly a 10 percent higher average price than those items it is replacing.
"We think the line could add as much as 100–200 bp to comp-store sales over the next couple of years," Juhan noted.
Management also sees an additional margin opportunity, driven by lower food cost/waste, given more cost effective ordering, delivering and food prep methods related to the brand. The up-front investment in the stores has already occurred, so all US company-operated stores are prepared for the rollout.
Meanwhile, pre-loaded dollars on smart phones are up 100 percent year over year while loyalty card pre-loaded dollars are up about 30 percent year over year. The Starbucks card continues to account for one-third of all US in-store transactions.
"Starbucks is recalibrating expectations for a lower-paced sales trajectory. Management believes that over the next couple of years, Starbucks can slowly reaccelerate channel development (CPG) rev growth back to a low-double-digit pace from the ~6% growth rate reported in FY3Q," Juhan said.
Moreover, the company sees a challenging environment and a struggle for market share in packaged coffee and food service given little to no growth in the overall market excluding single-serve. The company's recent price decrease in packaged coffee is mitigating growth in other areas.
Single-serve and international CPG distribution remain the real growth opportunities within the channel development division.
Internationally, Europe is benefiting from improved distribution is leading to a lower cost structure, and the company continues to rationalize G&A and expects to continue to take costs out of the model in the coming quarters.
The recently improved top-line results have been driven by improved consumer engagement, a re-commitment to training employees regarding consistent beverage production, the loyalty program, and an improved food program in the UK.
"The operating margin goal for Europe remains mid- to upper teens with healthy steps over a period of years from the current 3%-4% rate," Juhan wrote.
!In Asi! a Pacific, China remains a key country. Starbucks currently operates in about 70 cities within China with 70 percent of the stores in tier 1 and tier 2 cities. Expect future store growth to occur primarily in cities where Starbucks already has a presence. China/Asia Pacific comp growth was 9 percent for the third quarter as traffic growth sequentially doubled from the second quarter.
China should remain the fastest-growing geography for years to come. China's average unit volume (AUV) is approaching $900K. The afternoon day-part remains strong, and the morning coffee ritual is not cemented yet with the Chinese consumer.
"Expect a natural growth curve in China that should mature over time – think "10% comps with a band around that as a good comp projection," Juhan said.
Meanwhile, new products from Evolution Fresh (facilitated by the new DANONE agreement) coupled with additional health and wellness product iterations should drive comp.
Coffee costs could be a big tailwind for Starbucks. Coffee costs continue to decline with futures indicating about $1.15 a pound, down from the prior cycle high of over $3.00 in early 2011. While Starbucks has already contracted "well over" 80 percent of its coffee requirements for 2014, it could see continued meaningful commodity cost savings in 2015.
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