Wall Street wants more on Starbucks’ grocery plan

By Reuters
Posted Dec. 1, 2010 at 9:27 a.m.

Starbucks is prepared to make acquisitions to help accelerate sales of bagged coffee and other consumer products beyond its cafes, Chief Executive Howard Schultz told investors on Wednesday.

The brass at Starbucks Corp says the consumer packaged goods business should grow faster than the company’s retail cafes, which total 17,000 globally.

But Wall Street wants specifics on how it will accomplish that goal, particularly as it works through a messy break-up with Kraft Foods Inc, which has handled sales of Starbucks packaged coffee and tea in supermarkets and club stores since 1998. Speaking at the company’s investor meeting in New York, Schultz said the Seattle-based coffee giant was prepared to buy small and large companies that would help expand its selection of consumer products. Starbucks shares rose 3.3 percent in morning trading.

The company wants to sell more Starbucks-branded products, including packaged coffee and tea, Via instant coffee, bottled drinks and ice cream through channels ranging from supermarkets and warehouse stores to restaurants and hotels.

As one example, Schultz said the company’s Tazo tea business has “significant upside if we pay attention to it and invest in it.” Starbucks aims to build Via and its Seattle’s Best mid-tier coffee brand into billion-dollar businesses.

He said Starbucks would also focus on improving margins in its international cafe business and aim to attract more customers in the afternoon and evening hours.

For its fiscal year ended Oct. 3, packaged goods accounted for just 7 percent of Starbucks’ revenue of $10.7 billion. The company says it has healthy margins and lots of room to run.

Starbucks is also expected to provide more information about the locations of 400 new international and 100 new U.S. cafes planned for its new fiscal year.

Earlier this week, Starbucks accused Kraft of multiple contractual breaches, including mismanaging grocery sales. It wants to end the union on March 1, ahead of what it says was a 2014 expiration date.

In the 12 years Kraft has handled Starbucks grocery coffee and tea sales, revenue grew to $500 million from $50 million.

Kraft asserts that the deal is perpetual and denied breaching the contract. It said that if Starbucks wants out, it must pay Kraft the fair market value of the business plus a premium of as much as 35 percent.

If the companies do not settle their differences on their own, it will go before dispute resolution firm JAMS in Chicago.

The biggest unknown is how much Starbucks might have to pay for its freedom from Kraft.

Bernstein analyst Sara Senatore said the value of Kraft’s business could be around $1.2 billion, excluding any premium, if arbitrators agree that the contract is perpetual. If they agree with Starbucks that the pact would have expired in 2014, the value could be less than $300 million, she said.

“We would expect an arbitration award to be below the perpetuity value,” Senatore said, pointing to the complaints Starbucks has levied against Kraft.

Baird analyst David Tarantino said the divorce from Kraft could be a wash for Starbucks, which does not have expertise in placing products in grocery stores.

“We view the near-term benefits and risks of (Starbucks) taking over the packaged goods business as roughly balanced,” he said.

The Kraft deal brought Starbucks revenue of roughly $400 million in its fiscal year ended Oct. 3, according to regulatory documents. Starbucks makes some profit selling the roasted, bagged coffee to Kraft, which also pays Starbucks a separate fee based on grocery sales and other factors.

While revenue from the partnership rose more than 9 percent in 2010 and more than 8 percent in 2009, analysts say Starbucks has suffered three years of sequential market share losses. That was partly due to the success of rivals like Dunkin Donuts, which is distributed by J.M. Smucker Co, and Peet’s Coffee & Tea, which has won fans among a growing number of people who are brewing coffee at home to save money.

Analysts declined to estimate how much extra revenue Starbucks could pick up by taking the business back from Kraft.

“We believe the Starbucks (grocery packaged coffee) brand is ripe for reinvigoration,” said Senatore.

Starbucks on Monday told Reuters its new partner for the packaged coffee and tea business would be privately held Acosta Inc, which in one year helped Starbucks drive Via sales of about $135 million.

Ending the deal with Kraft would also break Starbucks’ tie to Kraft’s Tassimo single-cup brewing system, which is a distant rival to the Keurig brewer from Green Mountain Coffee Roasters Inc. Starbucks is not expected to make an announcement about single-cup brewing on Wednesday.

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