News Analysis date published New: 
Tuesday, July 17, 2012 - 08:30
New Date created: 
Tuesday, July 17, 2012 - 08:38
New Date last updated: 
Tuesday, July 17, 2012 - 08:30

This Well-Known Stock Just Entered its Second Phase of Big-Time Growth

Tuesday, July 17, 2012 - 8:30am

Everyone loves a good turnaround story. Nowhere is this truer than in the stock market.

When a company reverses its fortunes and rises from the ashes, earnings and profitability increase, new jobs are created and shares jump higher as investors reward a well-executed strategy. A good turnaround story inspires shareholder confidence and is a great way to pump up investor gains.

This is exactly what has transpired with this reborn market leader in the past three years.

Many investors believed the company's best days were behind it, with an overly aggressive expansion strategy and operational weaknesses weighing heavy on earnings and margins in the mid 2000s. But with the return of its founder as CEO and a rebranded corporate strategy in 2008, shares have seen huge gains, easily outpacing the S&P 500 since July of 2010 with an amazing 300% gain. Take a look at the eye-popping gains in the chart below, which shows gains from 2010 through 2012 compared to those of the S&P.

The company I am talking about is Starbucks Inc. (Nasdaq: SBUX), the world's largest coffee shop chain, with more than 19,500 locations in 58 countries and a market cap of $39 billion. The sharp gains in the past few years might be intimidating to investors reluctant to buy momentum, but a closer look at Starbucks reveals the company still has plenty of room to grow, particularly in international markets.

Bull case for Starbucks
China is driving the second phase of the Starbucks miracle-growth story, as CEO Howard Schultz remarked in the company's second-quarter earnings call from April 26. Growth in the country is reminiscent of what Starbucks experienced in the United States in the 1990s, where the company produced staggering annual sales gains that led to huge profits for early investors, Schultz said.

These comments were fueled by impressive growth numbers out of the China/Asia Pacific region, where second-quarter revenue jumped 32% from last year to $174 million while operating margins actually expanded to 39.8% from 33.2%. It was also the seventh consecutive quarter of 20% sales growth in China, which ranks its profit contribution among the highest in the company's history. As it stands, Starbucks operates 580 stores in more than 50 cities in China, but with more than half of its planned 300-400 new annual international store openings occurring in China, that number is expected to grow to 1,500 by 2015.

The company is also seeing huge gains in its efforts to enable loyal customers to bring the Starbucks experience into their homes. That is being driven by the success of Starbucks and Tazo-branded K-Cup portion packs, which are individual brewing packets of the company's very popular coffee products. When paired with the success of the company's packaged coffee products, which is just a little more than a year old, Starbucks' direct segment saw sales jump an amazing 57% from last year to $322 million, comprising 10% of total quarterly revenue of $3.2 billion.

But it's not all about surging growth for Starbucks. The company's legacy business in the Americas also continues to perform well. Accounting for 75% of Starbucks' total second-quarter revenue, with 12,811 stores in the United States and 1,284 in Canada, the region saw sales increase 7% from last year on a 6% increase in foot traffic and 1% increase in prices.

Risks to Consider: One of the biggest threats to Starbucks is volatility in input costs, particularly in the coffee-bean market. This scenario was on display from spring of 2010 to spring of 2011, when coffee-bean prices almost doubled on production disruptions. Although that inflationary movement turned out to be temporary, with prices eventually falling back to historical levels, coffee-bean prices stand to have a sharp effect on the company's operations and profitability.

Action to Take --> In spite of Starbucks' incredibly successful turnaround strategy, shares are currently trading 18% below the recent all-time high of $62 after falling sharply with the market in late April and May. This has helped sweeten the valuation picture, pushing its price-to-earnings growth ratio (PE/G) to just 1.28, a discount to the 10-year median of 1.43. But with analysts projecting annual earnings growth rates of 20% plus through 2014, this is a great opportunity to buy a resurgent growth stock that temporarily fell out of favor with the market on the heels of some very outsized gains and profit taking.

Michael Vodicka does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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