Coffeehouse's stock surges back

A dismal economy and a stiff challenge from the world's largest restaurant chain threatened to flush the burgeoning coffeehouse industry down the drain like a day-old cup of joe.

But after seeing its stock price plunge by more than 80 percent, Minneapolis-based Caribou Coffee has enjoyed a robust rebound that has more than tripled its stock since April. Starbucks, the Seattle-based industry leader, has had a similar rollercoaster run, dropping about 75 percent to about $7 a share before rebounding to its recent price of about $20.

The premium coffeehouse industry, which at one time was one of the fastest growing segments of the consumer sector, has suffered from increased competition and market saturation. Its troubles have been further compounded by the economic downturn and an aggressive ad campaign by McDonald's pushing its premium coffee products.

Starbucks responded by cutting costs and shutting down hundreds of its under-performing shops.

Caribou has taken a different approach, focusing on new concepts and different marketing avenues. When Michael Tattersfield stepped in as the new president and CEO last August, he brought in a new management team to help change the direction of the company, which had never turned a profit as a publicly traded company.

"We laid out what we felt we needed to do to start getting better year over year," explains Tattersfield. "It has been a year of putting building blocks in place."

Under the new strategy, the company has changed its emphasis on new locations, pushed harder to get its brand into retail outlets, cut some employees and tightened up its cost of operation. It also closed 10 under-performing coffeehouses in 2008 and dramatically curtailed its plans to open new shops. "We had been expanding the business too quickly," explains Tattersfield.

Caribou has about 500 coffeehouses in 16 states and the District of Columbia and sells its coffee in about 4,000 retail outlets, including Target. "Our commercial business has really taken off," says Tattersfield. "Five years ago, 97 percent of our business came from our retail coffee houses. Now it makes up less than 90 percent."

In addition to expanding its presence in retail stores, the company shifted its expansion emphasis from stand-alone coffeehouses to what Tattersfield calls "shops within a shop." The new shops are typically small outlets or kiosks in grocery stores, airports or shopping malls. "We expect to add at least 30 licensees [franchises] in that segment this year," says Tattersfield. "We really like that concept."

Going forward, Tattersfield says he plans to continue to expand the business primarily by adding new shop-within-a-shop locations and pushing its coffee beans into more retail outlets. "We also plan to continue to improve the coffeehouse experience with new beverages and food choices."

The company's sales have held up well in the face of growing competition from McDonald's. Tattersfield has tried to put a positive spin on the aggressive advertising campaign McDonald's has been running to promote its coffee offerings. "That has created more awareness in this industry," he says. "But we offer a very different experience with a very different line of products. We just need to continue to focus on the things we need to do to improve our business."

Through the first two quarters of 2009, Caribou reported net earnings of $1.51 million versus a loss of $8.84 million for the same period in 2008. It posted total revenue of $123.4 million for the latest six-month period, down slightly from $129 million during the same period a year ago.

David Tarantino, an analyst with Robert Baird & Co. who covers the coffeehouse industry, believes Caribou has solid prospects for future growth. "We see potential for Caribou to increase its EBITDA (earnings before interest, taxes, depreciation and amortization) by 15 percent-plus annually through retail growth, increases in commercial and franchising revenue, and margin improvement. A greater emphasis on licensing and commercial businesses plus heightened efforts to improve performance for company-operated retail locations should support better profitability."

Tarantino does, however, have some concerns for Caribou and the coffeehouse industry. Increased competition, inflationary pressure and continued weakness of the overall economy could affect profit margins. He also points out that Caribou's narrow geographic concentration could affect growth. "Since most stores are located in the Midwest, Caribou is susceptible to regional factors, including the economy, weather and political issues."

But he believes Caribou has done a good job differentiating itself from competitors. "Caribou has created distinctive positioning through offering high-quality coffee in a comfortable, lodge-like atmosphere, which contrasts with the trendy, upscale approach used by competitors, such as Starbucks." He rates Caribou stock as "neutral" based on its current price.

The stock closed Friday at $6.59 a share, about six times its 52-week low of $1.10.