The world’s largest coffee chain Starbucks Corporation (NASDAQ:SBUX) reported a surprising Q3 revenue shortfall of $23 million. But Morgan Stanley research remains bullish on Starbucks, with an overweight rating and price target of $56-58. John Glass of Morgan Stanley is confident that Verismo and an improved UK business will increase the company’s EPS by 15-20 percent annually.
In its recent report, Morgan Stanley discusses three issues: US same store sales, contribution of Verismo in total earnings, and opportunities in EMEA (Europe, Middle East and Africa). These are the key issues driving Starbucks shares up in the short term.
Morgan Stanley (NYSE:MS) is confident that the margin rates and US same store sales will stabilize in the fourth quarter. Last quarter, the same store sales were $2.3 billion, and have been growing at an average of 8 percent for the past three years, due to accelerated traffic. The researchers noticed that Starbucks customers are fragile, and they need value offers to come back to the coffee shop again and again. For example, this summer Starbucks again brought the “treat receipt” offer, where it gives a receipt to each of its customers. If people come back in the same afternoon, they could buy any Grande cold beverage for $2. Now it is running the K-cup promotion, which has a limited time “buy one get one” offer.
Verismo, a single serve coffee platform launched in mid-September at Starbucks Corporation (NASDAQ:SBUX)’s stores and select retail stores, is expected to contribute 3 cents in EPS in FY13. The contribution may further grow to 6-9 cents in FY14. Verismo will also help boost the US same store sales. Verismo machines are much cheaper than most of its direct competitors. Its price range starts at $99. Morgan Stanley says, in the long run, 70 percent of Verismo pods will be sold at the retail stores/groceries, and only 30 percent in Starbucks stores.
The results have been underwhelming in the EMEA segment, where the UK alone, makes up for the region’s 67 percent of Starbucks owned units. Starbucks Corporation (NASDAQ:SBUX) is troubled with the high cost real estate and strong competition from local vendors. While Starbucks sales deteriorated during the second and third quarters this year in the region, its biggest competitor in the UK, Costa Coffee registered a growth of 7.1 percent in the last six months. To make it more clear, EMEA contributes about 10 percent of Starbucks’ total sales, but only one percent of profits.
Starbucks recently announced plans to open its first store in India by October end. The company has huge potential in the Indian market, where it has formed a join-venture with Tata Global Beverages.