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Starbucks Only Thinks It's Brewing Growth in China


It may be a daily ritual for expats, but not for locals.

It's been quite some time since I remember opening up a Starbucks (SBUX) quarterly report with a smile. Thankfully last week's fourth-quarter results finally helped me regain some of my faith as a shareholder in the coffee giant.

Clearly on a mission to clean house and get his business back in order, Howard Schulz led his Starbucks team through major cost-cutting initiatives. The closing of over 800 inefficient and unnecessary US locations has nearly come to a close. Technological advances in daily operations were implemented. And brand loyalty is making a comeback.

The focal points of the quarter were the steps taken to streamline the business model, rather than the headline figures. Significant cost savings and margin expansion that occurred throughout the quarter were impressive. Cost of sales improved 520 basis points and operating margin grew 760 basis points.

Armed with innovative strategies, Starbucks is barging with full-force through this recession and its moves so far could open doors to favorable long-term growth as a maturing company. Of course, keep in mind that restructuring efforts can only keep profits buoyant for so long if sales can't be revived.

However, it seems like Starbucks is putting its best foot forward to set the top line in growth mode again. While I originally wasn't a fan of the newly launched VIA instant coffee line, initial response from consumers appears favorable, according to Starbucks. The company is continually refining its coffee bean selection and is in the middle of finding its optimal price architecture. See also Starbucks: The Free Market at Its Best.

Boosting its marketing efforts, Starbucks is utilizing social networking, which is a key component to effective brand building these days. The company was recognized as the number-one, most engaged brand online, the biggest brand on Facebook, and the biggest brand category on Twitter.

The only bone I have to pick with Starbucks is its optimistic growth outlook on China. In the conference call, it was mentioned that "Starbucks has become part of the daily Chinese ritual." That's a far-fetched comment, as I've yet to meet a local Chinese professional who drinks coffee, let alone Starbucks, on a daily basis.

Throughout my time in China, I've asked numerous Chinese for their attitude toward coffee and Starbucks. The only response I've gotten is that it's still considered a high-end luxury establishment and most only go to "treat" themselves. Take a gander through any Shanghai Starbucks and I'll bet you see a lot of non-Chinese faces. Perhaps I'm wrong, but the perception I've gotten thus far is that Starbucks in China may be a daily ritual for expats, but not locals.

While Starbuck's stock is inching closer to my purchase price, I'll be honest and say I'm not sure I'd buy in right now. I need to see a few more quarters of solid bottom-line performance and a bit of revenue boost. While competitor Caribou Coffee (CBOU) is just about out of the coffee race, Starbucks still faces fierce competition from Panera (PNRA), Green Mountain Coffee Roasters (GMCR) and McDonald's (MCD), with the later two being attractive options when discretionary cash is tight.

I have a lot of faith in Starbucks. After all, I'm still a shareholder after riding the stock down well over 60%. However, I recommend being cautious in terms of buying in at 19 times forward earnings as I question whether the stock's current momentum will carry through in the near term.
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Position in SBUX.
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