Starbucks Brews Up Opportunity in China

By Josh Lipton

A typical Chinese breakfast might include stuffed rice rolls, fried bean curd, and a bowl of plain rice porridge served with a side of salted duck eggs. But Starbucks (SBUX) is now hoping that the Chinese will add a new item to that well rounded menu: instant coffee.

Specifically, the coffee giant is reportedly now launching its instant coffee packets in China. The Seattle-based company's “Via” branded single serving coffee packets will be available in more than 800 stores across China, Hong Kong, and Taiwan beginning April 6. The coffee will also be distributed in hotels and grocery stores, according to John Culver, president of Starbucks.

“We see a big opportunity in packaged goods in China,” Culver told the Wall Street Journal.

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Analysts covering the coffee powerhouse argue that, though there are still intriguing domestic opportunities for Starbucks, international markets will be its primary growth vehicle going forward. And China, in particular, is considered the place to be: in fact, the front office of Starbucks believes that one day that country will be the largest market for its products outside the US. The company has more than 5,500 units in more than 50 countries, including 700 already operating in China.

“This is a smart move by the company,” says RJ Hottovy, a Morningstar equity analyst who covers Starbucks. “Introducing this product is the next step for them as they try to canvas the entire Chinese market.”

Via enjoyed success Stateside, Hottovy notes, with $180 million in sales in the year after its launch, and he's confident it can capture that same positive interest among Chinese consumers. “China is obviously a high growth market, and this certainly could have an impact over the medium term for the company.”

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Hottovy emphasizes that Starbucks remains the dominant player in specialty coffee. However, he's also skeptical that the company will enjoy the sort of lofty, 20% revenue growth rates of years past. While the firm maintains a sizable lead over direct domestic rivals like Caribou Coffee (CBOU) and Peet's (PEET), he says, it does face credible competitive threats from quick-service restaurants.

For instance, he points out that McDonald's (MCD) generated about $1.5 billion in coffee sales through its 14,000 domestic units in 2009. The analyst says Starbucks investors should now expect a solid, albeit more modest, long-term growth trajectory.

After a 45% run up in the stock price in just the last 12 months, Hottovy says Starbucks' shares now look fairly valued. This afternoon, Starbucks was up 1.9% to $34.24.

Erik Kolb, the S&P equity analyst who covers Starbucks, reacted to the news by raising his fiscal year 2012 EPS forecast to $1.71 from $1.45 and lifting his target price to $38 from $35.

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Kolb told clients that he increased his EPS estimates on the company's further efforts to enter the at-home market as well as its continued geographic expansion. The analyst also said that he expects positive sales momentum to generally offset rising coffee commodity costs.

Kolb does think the company boasts significant financial strength and cost cutting efforts such as store closings and personnel reductions, he says, has further bolstered the company's finances. However, worried in part by the risk posed to the company from competitors, Kolb at this point told clients that he remains lukewarm on the shares.

He rates Starbucks a Hold.

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