Peet's: Not Your Average Joe

Rather than go toe-to-toe with Starbuck's, the upstart vendor of gourmet coffee has its own strategy -- one investors seem to like

In the battle for specialty-coffee supremacy, there is Starbucks (SBUX ), and there is everyone else. But if Peet's Coffee & Tea Inc. (PEET ) has its way, it could command similar dominance in the fresh-roasted, whole-bean market.

After its Jan. 25 IPO raised $30 million -- with $20 million in proceeds to the company -- plucky Peet's is pushing to build its brand and grow its business. By selling coffee not only in retail outlets but also via mail order, the Internet, specialty grocers, offices, and restaurants, the Emeryville (Calif.)-based company believes it can emerge with a healthy portion of the highly fragmented gourmet-coffee business, now estimated at $7.5 billion annually. Roughly half of that comes from whole-bean sales -- Peet's target -- as opposed to already-brewed or coffee in the cup.

This is not a battle for first place. Coffee colossus Starbucks Corp. is still king on that score, at least in the retail category. With nearly $2.2 billion in revenues last year and more than 4,100 outlets worldwide, it dwarfs its nearest competitors. Peet's is small beans by comparison, with 59 retail stores and sales of $84 million in 2000. Its aim is not to butt heads with Starbucks but to piggyback on the Seattle company's success in opening up the high-end market, which now makes up more than a third -- and the fastest-growing segment -- of the overall $18.5 billion U.S. coffee industry. That's up from $13 billion in 1993, according to the National Coffee Association of the USA.

"Starbucks is the instigator, the vehicle," says Peet's President and CEO Christopher Mottern, a former wine-industry exec who compares what has happened with coffee to the way consumers gravitated from jug to premium wines over the past two decades. "Like the wine business, once people develop a taste for more full-flavored foods, they demand them and want them in other locales, such as at home and in restaurants," he says.


  Peet's was founded in 1966 by Dutch immigrant Alfred Peet in Berkeley, Calif. Peet, who left the business in 1979, roasted coffee in his store and offered customers a free cup for every pound of beans purchased. The coffee's rich, deep-bodied roast quickly developed a cult following in Northern California, so much so that devotees are known as "Peetniks."

Peet's boasts of shipping to destinations as far away as Mongolia and the South Pole. Ironically, it was acquired by Starbucks in 1984 and then spun off three years later to two Starbucks' founders, including Gerald Baldwin, who remains Peet's largest shareholder and sits on its board. In some ways, the company has never strayed from that cup-and-bean strategy. Sixty percent of its store sales are derived from whole-bean products. Other retailers generally generate whole-bean sales of 10% or less.

The company further differentiates itself with a targeted plan aimed at expanding whole-bean sales rather than moving more cups of brewed coffee, though obviously the two go hand in hand. Its nonretail-store strategy means it will open only three to five outlets a year. Ultimately, Mottern says, the goal is to derive 50% of all sales in about five years from the Internet and channels other than retail, which accounts for about 80% today.


  That won't be easy. The company has struggled of late, as it spends heavily on marketing and building up its distribution and technology infrastructure. Indeed, it reported a loss of $2.3 million in 2000. Other risks abound. The California energy crisis could take a serious bite out of profits, since more than 80% of Peet's stores are in the Golden State. And it faces steep competition from numerous other retailers and wholesalers, including large companies such as Millstone and Gevalia and independents like Green Mountain, not to mention an estimated 500 local brands.

Now, Peet's must convince consumers that its fresh-roasted beans are better than the competition. That might not be easy: An extended economic downturn could affect coffee sales, as consumers trim spending wherever they can. Even Starbucks, in an earnings report released Apr. 27, lowered its expectation of same-store sales growth to the low single digits in light of the depressed economy.

But CEO Mottern says Peet's plan is just beginning to percolate. In the last three years, it has increased roasting capacity by 30%, moved smartly into select markets, such as Southern California and Chicago, forged alliances with corporate clients like Cisco Systems Inc., Gap Inc., and Disney to deliver coffee to their office workers, and teamed with upscale restaurants such as Spago in Los Angeles. It now sells coffee and tea in about 50 gourmet grocers, but has plans to be in 70 by yearend. After that, the company has identified another 10,000 distribution or grocery outlets where Peet's can be sold.


  The diversified strategy seems to be paying off. Citing a strong 67.5% increase in specialty sales, which includes office, wholesale, and grocery, Peet's reported a narrower first-quarter loss of $0.3 million, or 4 cents per share, on May 2. That was in line with, or a penny less, than analysts' estimates. By way of comparison, the first quarter of 2000 saw a loss of $0.6 million, or 14 cents per share. Net sales for the period ended Apr. 1 increased 15.2%, to $22.6 million, from $19.6 million. Also, specialty and mail order/online revenues accounted for nearly 20% of sales, vs. 17% for the same period last year. Mottern said that "demonstrates our ability to grow outside of our retail stores."

Peet's has also earned a reputation for working closely with partners to ensure the quality and placement of its product in order to build brand awareness. Bristol Farms, a 12-chain specialty grocer in Southern California, introduced Peet's in 1998 and has seen sales increase every year -- including a leap of more than 25% so far this year. "Our coffee business has outpaced our store business," says Charlie Bergh, Bristol Farms' vice-president of marketing.

Mottern is optimistic. "Going public reduced our debt to almost nothing, so we have a chance to leverage that for expansion," he asserts. "Now, we can be flexible and opportunistic with our plan." Analysts agree: "The strategy makes a lot of sense," says Peter Swan, a securities analyst at Pacific Growth Equities. "Peet's is targeting whole beans as opposed to cups of coffee. You already have a significant base of retail stores out there, so it doesn't make sense for Peet's to take a scattershot approach and build a bunch of stores."


  Swan estimates earnings-per-share growth of 20% to 25% over the next five years. Investors seem to think he's on to something. In a year in which the IPO market all but dried up, and even Web-browser pioneer Marc Andreessen struggled to convince investors to participate in his Loudcloud Inc., Peet's has performed surprisingly well. The stock hovers in the $9.70 a share range, up slightly from its $8 IPO price. The stock closed at $9.60 on May 2, up 10 cents.

While analysts such as Swan and Kristine Koerber of WR Hambrecht & Co. both estimate a loss for the company for the first six months of this year, they expect earnings to rebound in the second half of 2001. Koerber anticipates a profit of $0.05 per share in 2001 and an upswing to $0.35 in 2002. Both WR Hambrecht and Pacific Growth Equities helped underwrite Peet's IPO.

Even in tough times, Peet's executives argue, coffee is an "affordable luxury" that most consumers are unwilling to give up. Take Tom Dailey. Sitting inside a Peet's Coffee store in Oakland, Calif., Dailey explains why, even in an economic downturn, he's reluctant to cut back on his favorite cup of java. "My children would go shoeless first," he jokes. Now, all Peet's has to do is to make coffee drinkers across the country feel like Tom Dailey.

By Douglas Robson in San Mateo

Edited by Douglas Harbrecht

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