Menu Innovation Helps Drive Strong Growth At Starbucks

| About: Starbucks Corporation (SBUX)

Coffee retailer Starbucks (NASDAQ:SBUX) reported solid results for the first quarter of its 2013 fiscal year. Sales surged 11% year-over-year to $3.8 billion, roughly in-line with consensus estimates. Earnings were also solid, growing 14% year-over-year to $0.57 per share, also equal to the consensus expectations.

Although most food and beverage retailers are looking to grow internationally, Starbucks posted great results in its Americas segment, where revenue jumped 10% on same-store sales growth of 7%. At the firm's annual meeting, it explained the need to open more locations in the US, and strong results suggest management is correct. The firm's operating margin declined 50 basis points year-over-year to 20.8% due to litigation and Hurricane Sandy, though we think some of the compression can be attributed to higher input costs. The US business is doing incredibly well, and we do not see any slowdown in the near term. We believe the company still has expansion opportunities via drive-thrus and increased menu offerings.

Starbuck's China/Asia segment experienced wonderful first-quarter results, with revenue jumping 28% year-over-year to $214 million, thanks to the addition of 125 new stores and 11% same-store sales growth. Though growth hasn't been quite as robust as it has been in the United States, management remains extremely bullish about the country's future:

"We started our journey in China with our first store in Beijing in 1999, and in Q1 we celebrated the opening of our 100th store in that extraordinary city. China remains Starbucks' most significant market opportunity in this region, and is well on its way to becoming our second-largest global market in 2014. Today we are proud to operate over 700 stores in mainland China, and we are on plan to have 1,500 Starbucks stores in over 70 cities across China in 2015."

Operating income in the segment jumped 26% year-over-year to $72 million. Even though margins contracted 60 basis points to 33.7%, we're not at all worried about the firm's profitability in Asia at this time.

EMEA (Europe, Middle East, and Africa) struggled during the first quarter, with sales growing just 1% year-over-year to $306.7 million, as the firm added only 7 stores and experienced a decline of 1% in same-store sales. Competitive pressures in the segment are much stronger than in Asia, but the broader macroeconomic challenges certainly aren't helping. Still, Starbucks' decision to focus on licensing and closing unproductive stores led to a 110 basis-point jump in operating margins (7.3%), which increased operating income 18% during the quarter. Overall profitability should be stronger due to a better margin profile in EMEA, but the segment remains a fairly small part of the overall revenue mix.

Channel development chugged along during the quarter, with sales jumping 13% year-over-year to $380 million. Operating income advanced an impressive 24% during the quarter to $97 million thanks to significant margin improvement. Although the launch of a device like the Verismo would traditionally hurt the firm's margin mix, the decrease in coffee costs more than offset the negative impact.

Looking ahead to the company's fiscal 2013 targets, Starbucks reiterated its earnings guidance of $2.06-$2.15 per share, on revenue growth of 10-13% and same-store sales expansion in the mid-single digits. The firm expects to open 600 net new stores in both the Americas and in China and thinks operating margins are on target to advance 100 basis points over fiscal year 2012.

Though the outlook is achievable, Starbucks' current valuation is lofty via an earnings multiple perspective. After slipping in the mid-2000's, CEO Howard Schultz's second term atop his company has been marked by a re-acceleration in growth and improved profitability. We like the firm's future outlook in China and the reinvigoration of its domestic business, but we would only add shares to the portfolio of our Best Ideas Newsletter at a price below our fair value estimate range (and with a stronger Valuentum Buying Index score).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.