Hot Stocks: Starbucks Turnaround Brings Back the Grande Profits

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Reaping the fruits of a remarkable turnaround, Starbucks Corp. (Nasdaq: SBUX) last week reported a 20% increase in profit just days after learning it had become the No. 3 restaurant chain in the United States.

Such achievements were virtually unthinkable back in 2008, when the coffee store chain's annual profits plummeted 53.1% to $315 million from $672.6 million the year before (Starbucks' fiscal year ends September 30).

But lately Starbucks has been on a winning streak.

"What they've done to turn the company around has been nothing short of remarkable," R.J. Hottovy, an analyst with Morningstar, told Retail Traffic. "They are very well positioned and I think there are still some growth opportunities for them out there."

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At least someone must know this coffee company…

Starbucks reported a profit of $261.6 million for the quarter ended April 3, compared to $217.3 million a year ago. Comparable store sales were up 7%, with the number of transactions up 6%.

The company raised its full-year profit forecast to $1.46 to $1.48 per share as its rebound continues; Starbucks earned $1.28 per share in 2010 and just 84 cents per share in 2009. Revenue for the quarter was up 10% to $2.8 billion.

Rising sales helped vault Starbucks ahead of burger stalwarts Wendy's Arby's Group Inc. (NYSE: WEN) and Burger King Corporation to take third place in Technomic Inc.'s annual ranking of U.S. restaurant chains. McDonald's Corporation (NYSE: MCD) and Subway are ranked No. 1 and No. 2 by revenue.

Starbucks' rising popularity partly reflects shifting tastes among Americans toward healthier foods, a trend that should continue to benefit the company.

But much of the company's current success also results from the difficult steps it took in 2008, when excessive growth - Starbucks at one point was opening seven new stores every day - and the onset of the Great Recession combined to put the company flat on its back.

"The big issue I think was that growth is not a strategy, it is a tactic, and if growth becomes a strategy I don't think it is an enduring one," Starbucks Chief Executive Officer Howard Schultz told The Guardian last year. "I think growth covers up mistakes."

So Starbucks closed 616 underperforming stores in 2008; 300 more followed in 2009, and it drastically cut back the number of new stores it planned to open. Schultz trimmed 1,000 positions from the corporate structure and squeezed out $600 million in operating costs.

Of course, it wasn't all slash and burn.

Starbucks began advertising for the first time. In February 2008 every store closed for three hours on the same day to retrain employees. The food menu was revamped, with some sandwiches eliminated and a breakfast value meal added.

And the company has relentlessly added more arrows to the quiver of its growth strategy. In 2009 it launched its Via line of instant coffee, designed as a cheaper alternative for customers when stopping by a store isn't an option.

Last week Schultz said the Via products had exceeded expectations, which will mean expansion of the line.

"The success of [Via] demonstrates the opportunities that we have to develop other food and beverage products," Schultz told Bloomberg News. "Via will be a portfolio of products."

Starbucks also has been busy expanding and reinventing Seattle's Best Coffee, which it bought back in 2003, as a working-class alternative to the mother brand. Seattle's Best is now available in 50,000 locations, a 12-fold increase over a year ago, with plans to grow to 100,000 locations.

Schultz has set a $1 billion annual revenue goal for Seattle's Best.

Earlier this year Starbucks announced plans to introduce a line of single-cup brewing machines for home use to try to capture a piece of the fastest growing segment of the U.S. coffee market.

Starbucks has redoubled its efforts to make its packaged products available in grocery stores.

Schultz said in March at the annual shareholders meeting that he believes grocery sales could eventually "rival the success of our Starbucks retail business." Packaged goods currently make up just 7% of the company's sales.

And Starbucks is still opening new stores both in the United States and abroad and is "ahead of plan" to open 100 new U.S. locations this year.

But the biggest growth is expected in China. Though Starbucks already dominates the Chinese coffee shop market with more than 70% of the market share, it would like to expand from 450 stores to 1,500 by 2015.

Yet its stock slumped about 2% last week after the company announced earnings. Investors worried that Starbucks' outlook fell short of analysts' expectations, and that higher commodity costs for coffee and dairy products would pinch future profits.

Futures for the Arabica coffee beans that Starbucks uses in its brews hit a 34-year high of $3.025 a pound two weeks ago because of poor harvests, a weak dollar and rising demand in countries like China, Brazil, India and Indonesia.

Starbucks said last week it expected high commodity prices to shave 22 cents from its earnings this year.

Schultz said he wasn't overly concerned, though.

"[The coffee prices] we see today are not sustainable," Schultz told Reuters. "And hopefully we will see it come down to more reasonable levels."

Given that Starbucks is otherwise hitting on all cylinders, it stands to reap a major boost from any reduction in commodity prices.

"There is no doubt that Starbucks has made a tremendous comeback from a couple of years ago, when they were struggling quite a bit," Jack Russo, an analyst at Edward Jones & Co. told Bloomberg. "As the economy recovers, people have a little bit more money to spend on premium-type product. They should continue to benefit from an improving economy."

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