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Starbucks' Secret Recipe for Growth

NEW YORK (TheStreet) -- Starbucks (SBUX), the largest U.S. coffee retailer, has a lot on its plate. The company is adding food and drink items, pushing into supermarkets around the world, building more shops and devising novel payment platforms.

Thankfully for investors, Starbucks' own java-addicted customers may help guide it through an ambitious expansion plan that risks overreach, which burned the coffee roaster over a decade ago.

As Seattle-based Starbucks undergoes what may amount to CEO Howard Schultz's second major growth offensive after retaking the reins, he may have an unappreciated buffer against slip-ups.


An increasing reliance by customers on pre-paid loyalty cards and mobile applications may help Starbucks in its roll out of recent acquisitions such as juice maker Evolution Fresh, tea specialist Teavanna and bakery chain La Boulange.

Meanwhile, as Starbucks builds its payments capabilities through a partnership with Square, a popular loyalty platform and a highly rated smartphone app, it may have the right infrastructure to grow in emerging markets like India and China.

Starbucks' unique growth agenda, and the risk it carries, has been a key theme for the company's earnings, given a backdrop of stable profit from existing stores and retail channels. Still, an upbeat outlook and strong performance from lesser-known areas of the company are a welcome surprise.

The performance of what's called the Starbucks Card was the highlight this holiday season, and that could give Starbucks reason to expect consistent growth in 2013 amid a year of expansion.

In the first quarter of 2013, Starbucks saw $1 billion loaded on Starbucks Cards, a 25% increase from a year earlier and a new record for the company.


That figure would have amounted to about a quarter of the company's overall revenue of $3.8 billion if card loads were immediately recorded as sales.

Taken another way, the Starbucks Card accounted for 25% of all U.S. tender, the company noted on an earnings call. The card's 20%-plus growth rate far exceeded overall revenue and same-store sales growth of 11% and 6%, respectively.

"This is a positive for sales, and [Starbucks] indicated that its strong U.S. sales trend has continued in January," Joseph Buckley, a Bank of America Merrill Lynch analyst, wrote of figures from the Starbucks Card and the company's earnings outlook.

"The growth in members and value loaded on Cards is very encouraging both near and long term."

CEO Schultz was exuberant.

"In terms of what happened in holiday in Starbucks Card, I must say it was stunning and almost unbelievable," he said on the company's January earnings call.

A discussion with analysts and an executive overseeing the Starbucks Card indicates that Schultz's excitement may stem from the unit's importance to the company's overall expansion, a key investor pitch in recent quarters.

In early December, Starbucks unveiled what it called an "accelerated growth plan," which includes 3,000 new store openings in the U.S. over four years, a doubling of its retail footprint internationally by 2015, and a transformation of its payment platform in coming years.

Recent acquisitions, the company's investment in ventures like Square and its own rollout of single-serve products such as VIA, K-Cups and a Verisimo brewing system are other key drivers.

The Starbucks Card and corresponding loyalty and mobile payments initiatives are crucial.

In a February interview, Ryan Records, a vice president of payments and cards at Starbucks, highlighted rising amounts of money being loaded on the Starbucks Card, a holiday-season spike in new loyalty program members and strong mobile app downloads as reason to see the unit as being increasingly relevant to Starbucks.


"When you do talk about the dollars that are loaded on a Starbucks Card, that is the pre-payment of coffee and food items," Records said. "It is a very positive sign that these numbers are going up."

The Starbucks Card is intertwined with the company's mobile payments strategy, which is expected to represent 10% of payments in Starbucks U.S. stores by the end of fiscal 2013, according to a December statement by the company.

Card uploads and a loyalty program may help Wall Street better forecast earnings.

"It potentially means less volatility," said R.J. Hottovy, an analyst at Morningstar. "If people have this revenue upfront, it does give you some protection from an economic downturn."

Records, the Starbucks VP, also highlights his unit's importance to initiatives such as the recent Teavanna acquisition and an expansion into emerging markets.

He is planning how to integrate the Starbucks Card and payments programs with Teavanna. Meanwhile, the company has indicated it will try to use the platform across its retail channel, a potentially groundbreaking development.

"The most important aspect is nobody has done this," Nicole Miller Regan, a managing director of research at Piper Jaffray, said in an interview. "A channel-agnostic loyalty program is going to be the first of its kind, and it is going to be very powerful."

Still, Regan is most excited about the natural growth of Starbucks' existing platform, highlighting the company's same-store sales growth and Schultz's execution on a rollout of Starbucks consumer-products businesses, such as VIA, packaged coffee and its K-Cup initiative.

"That is what's moving the needle now," Regan said.

While fast-growing card and payment programs may remain an afterthought for analysts in upcoming earnings, "it does offer them the foresight to confidently spend or invest," Regan added.

Starbucks will be spending heavily in coming quarters opening new stores and building out its international operations.

Given Starbucks' growing ability to track sales by way of novel card and payment's platforms -- a highlight of recent earnings -- there may be less risk in Schultz's expansion plan than some might expect.

Being ahead of the curve on new developments to retail such as mobile payments and app-based loyalty schemes also may allow Starbucks to adapt to quickly shifting consumer habits.

"I wouldn't rule anything out, this payments space is fast moving," Records said.

-- Written by Antoine Gara in New York

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