Tuesday, April 08, 2008

Pike Place Roast Coffee: The Profit Will Not Be in This Cup at Starbucks Corp.

Starbucks Corp (SBUX-$18.04) launched its new brewed coffee, Pike Place Roast, today at its company-operated stores in the U.S.

The new coffee is intentionally named after the location of Starbucks' first store, which opened in Seattle's Pike Place Market in 1971.

At the coffee purveyor's annual meeting last month, the founder and CEO Howard Schultz told shareholders: "We are returning to the very best elements of our heritage and bringing back the simple romance and excitement of coffee. Since 1971, we have sourced, roasted and sold the world's finest coffees. By highlighting that history through Pike Place Roast, and bringing back the sounds and aromas of the coffeehouse, we are raising the bar on what it means to serve the perfect cup of coffee."

To further elevate the fresh brewed coffee experience for its customers, stores also will brew smaller batches with a hold time of no more than 30 minutes.

Emphasizing Pike Place’s smooth taste, the company wants to bring back customers who fled to Dunkin' Donuts and McDonald's Corp, claiming Starbuck’s coffee tasted too strong or burnt.

Nonetheless, the 10Q Detective does not believe that this back to basics initiative will yield a material increase in traffic or average value per transaction. Brewed coffee, assorted coffee beverages, and a broad selection of Italian-style espresso beverages already account for 85 percent of net sales. Starbuck’s emphasis on a differentiated 'store experience' business model will not bring back Schultz's yearning for the local coffeehouse hangout of yesteryear—not for a company with more than 6,800 retail outlets in the U.S., and not with a cup of Pike Place Roast costing almost as much as a loaf of bread.

To execute on more meaningful innovation, management ought to invest its capital on true growth potential, such as expanding retail operations overseas (China).

And here's a thought, Mr. Schultz, instead of expanding the menu--including coffee beverages--cut the daily offerings on the chalkboard. Simplify beverage and food service items--and then focus on the coffee experience!

Margin Pressures

In the U.S., the premier roaster and retailer of specialty coffee needs to focus on operational efficiencies—its costs:
  1. During fiscal 2007, “C” coffee commodity prices traded on the New York Board of Trade within a price range of $1.00 to $1.35 per pound and prices were, on average, approximately 10 percent higher than in fiscal 2006. Prices continue to move higher during fiscal 2008, with July contracts at about $1.37 per pound. Starbucks will likely need to increase the use of price-to-be-fixed purchase contracts to meet its demand for coffee. By volume, approximately 20 percent of the Company’s coffee purchase agreements entered during fiscal 2007 were price-to-be-fixed contracts.
  2. In addition to coffee, the Company also purchases significant amounts of dairy products, particularly fluid milk, to support the needs of its Company-operated retail stores. Dairy expense for the U.S. segment represents approximately 75 percent of the Company’s total dairy expense. Looking at Dairy, February’s Class I Fluid Milk price (fresh milk product) is at $19.68, more than $6.29 higher than a year ago. And, according to company regulatory filings—unlike coffee beans—commodity costs for fluid milk are difficult to effectively hedge.

Investment Considerations

Despite management plans to expand its international retail operations, the Company’s
financial performance remains highly dependent on its United States operating segment, which comprised 78 percent of consolidated total net revenues in fiscal 2007. As such, we are not optimistic that select initiatives to leverage the Starbucks brand through the introduction of new products, such as Pike Place Roast, will do much to percolate share-net or the share price of Starbucks Corp. AVOID

Editor David J Phillips does not hold financial interests in any of the companies mentioned in this posting. The 10Q Detective has a Full Disclosure policy.


Anonymous said...

SBUX: About 12-18 months ago I dug into their sales/profit geographical breakout and found that (I think) profits per US store had dropped by a whopping 10%.

Further, it seems that the company line starting, of course, with Schultz is to poo-hoo the competition. I guess that's ok as ploy but as a corporate reality it would and could be distasterous.

Anonymous said...

hm. interesting take on Starbucks and McD's... I just read an article on a similar topic at http://fisher-investments.blogspot.com. Check it out.