Report Sees Starbucks Growth

The company update report, written by analyst Jeffrey Bernstein of Lehman Bros. in New York, follows a visit to the Starbucks headquarters in Seattle. Based on meetings with Starbucks management, including CEO Jim Donald and CFO Michael Casey, the report says the Starbucks strategy holds the promise of "potential opportunities for further expansion within as well as outside of the coffee segment."

Starbucks has only a few hundred stores operating in China, but the company "now sees the opportunity as greater than ever imagined and cannot open stores fast enough" in China, according to the report. "China is ultimately expected to be the largest market outside of the US," it says. The main barriers to growth in the country are the pace of infrastructure development and the capacity to hire and train the proper partners, according to the report.

In the US, Starbucks continues to open more stores every year than it opened the year before, and expects to grow to 15,000 stores from its current 7,700. At its current growth rate the company would reach that long-term target within four years, "giving some investors reason to believe growth may slow," Lehman Bros, says, but with the increasing success of its drive-through stores, along with off-highway and retail licensed locations, "management believes the long-term target can increase well above those levels."Outside of the US, Starbucks has a base of 3,200 stores and a long-term target for at least 15,000 stores. "Growth is limited only by the ability to build and staff the units without tarnishing the Starbucks experience," the report says. It expects that the company will continue to increase its worldwide annual unit openings.Factors driving Starbucks growth will include further expansion of its breakfast and lunch business, growth in gift card sales and other new directions for the company. The report notes that Starbucks management believes that stores in Europe will not achieve the profit margins of US locations because of significantly higher occupancy costs in Europe, but stores in Asia should be able to match US margins.

The Lehman Bros. report reiterates its rating of Starbucks stock as "overweight," which means that the stock is expected to outperform the unweighted expected total return of the industry over the next 12 months. While the stock was down about 4% for 2005, it is trading at the relative midpoint of historical ranges, "supporting our belief that Starbucks represents a compelling value for long-term investors," Lehman Bros. says.