Shares of Starbucks (SBUX) are hitting fresh all-time highs after the release of its third-quarter results. Investors and analysts are wildly enthusiastic about accelerating comparable-store sales. The company's strategy to increase sales by offering other beverages and food in existing stores seems to be paying off already.
While I continue to see further room for store openings and positive comparable-store sales growth I am hesitant to invest at these levels. The limited margin expansion possibilities after 2014 and high current valuation make me want to stay on the sidelines.
Starbucks generated third-quarter revenues of $3.74 billion, up 13.3% on the year before. Growth was mainly driven by a 8% jump in comparable sales, which was driven by a 7% increase in traffic. Comparable-store sales easily surpassed consensus estimates of 5.8%.
Operating income rose by 25% towards $615.2 million as operating margins increased by 150 basis points to 16.4% of total revenues. Consequently, earnings per share rose by 28% to $0.55 per share, beating consensus estimates by two cents.
During the quarter Starbucks net opened 341 stores, or almost four per calendar day. The company now operates 19,209 stores across the globe.
CEO and Chairman Howard Schultz commented on the performance during the quarter:
Starbucks Q3 results represent the best across-the-board third-quarter performance in our 42-year history. Our more than 19,000 store global footprint, our fast-growing CPG presence and our best-in-class digital, card, loyalty and mobile capabilities are creating a 'flywheel' effect elevating the relevancy of all things Starbucks, and driving profitability.
Looking Into The Results
It is really positive to see that Starbucks does not rely on pricing, which was up by merely 1%, to drive revenue growth.
It was mostly the healthy traffic growth and new store openings driving sales increases. Growth was healthy across all continents, with the exception of Europe, Middle-East and Africa which saw a mere 2% jump in revenues.
Starbucks still relies heavily on its North American business, which generates 75% of total revenues. Revenues rose by 12% to $2.78 billion, thanks to a very solid comparable-store sales increase of 9%. Operating earnings rose by 24% to $619.3 million as operating margins rose by an impressive 210 basis points to 22.3% of total revenues. Margins rose on the back of positive sales leverage and lower coffee costs.
The European and Middle-East activities reported 2% revenue growth to $287.2 million. Store optimization efforts boosted operating income by 260 basis points to 3.2% of total revenues.
The Asian and Chinese activities continued to see healthy growth. Revenues were up by 29% to $233.7 million. Yet the business is incredibly profitable, generating operating profits of $84.7 million. Operating margins rose by another 250 basis points to an incredible 36.2% of total revenues.
Full Year And Next Year's Targets
Starbucks sees its fourth-quarter operating margins increasing by 100 basis points on the year before. Earnings per share are expected to come in between $0.59 and $0.60 per share, including a $0.03 gain related to the sale of equity in the Argentina and Chile business. Consequently, full-year earnings per share are expected to come in between $2.22 and $2.23 per share.
For the upcoming year, Starbuck's fiscal 2014, the company expects to generate revenue growth of 10 to 13%, driven by mid-single-digit comparable-store sales growth. The company expects to open 1,400 new stores, half of which in the Asia-Pacific region.
Operating margins are expected to improve by another 150 to 200 basis points. All this should result in 18 to 22% earnings per share growth. As such earnings per share are expected to come in between $2.55 and $2.65 per share.
Starbucks did not provide a balance sheet yet with its third-quarter press release. The company ended its second quarter with $1.70 billion in cash and equivalents, while operating with $550 million in total debt, for a net cash position of around $1.15 billion.
Revenues for the first nine months of the year came in at $11.09 billion, up 11.7% on the year. Net earnings rose by 21.0% towards $1.24 billion, with earnings per share advancing by 22.6% towards $1.63 per share. The company is on track to generate annual revenues of around $15 billion on which it could earn almost $1.7 billion for this year.
Trading around $73 per share, the market values Starbucks at $55 billion, or its operating assets around $54 billion. This values its operating assets at 3.6 times annual revenues and 31-32 times annual earnings.
Starbucks currently pays a quarterly dividend of $0.21 per share, for an annual dividend yield of 1.2%.
Some Historical Perspective
Long-term investors in Starbucks have seen impressive results under command of Howard Schultz. Shares rose from $15 in 2003, to highs of $40 per share back in 2006. The departure of Schultz, mismanagement and the recession sent shares to lows around $10 back in 2008.
Ever since his return in the second half of 2008, shares have shown impressive and steady gains, currently exchanging hands at $73 per share, setting fresh all-time highs along the way.
Between its fiscal 2009 and 2012, Starbucks had increased its annual revenues by a cumulative 37% towards $13.3 billion with revenue growth accelerating in recent years. Net earnings more than tripled in the meantime, coming in just below $1.4 billion in 2012.
Starbucks continues to surprise me with accelerating revenue growth. The company still relies heavily on its U.S. operations. Its international expansion plans have struggled, notably in Europe and the Middle East. The small Asian activities are immensely profitable though and growing really fast. No wonder the company plans half of its openings for next year in the region, with an expected 700 openings.
The strategy to diversify its offerings in its existing locations is paying off handsomely with really strong comparable-store sales growth rates.
The company has broadened its offerings in a range of categories. For example, Starbucks now offers fruit "refresher" drinks and its strong line of Frappuccino ice beverages helps the company to perform well during the traditionally weaker summer months.
Recently it announced the strategic agreement with Danone (DANOY.PK) to sell healthy specialty yoghurt's in its stores by next year. Starbucks also acquired La Boulange and Teavana over the past year to increase its offering of bakeries and specialty teas, helping to boost average spending per ticket. Yet, these initiatives are just starting to come online. La Boulange's offerings are only found in some 1,076 stores, just 5% of the worldwide store base.
As such average consumers are no longer just coming to Starbucks to get a coffee, many can opt for a quick snack or a refreshing non-coffee beverage as well. These initiatives are furthermore aided by its loyalty card program.
While the results are impressive, and it is a positive that Starbucks already gave an upbeat guidance for next year, I remain on the sidelines on valuation concerns.
Despite forecasting revenue expansion towards $17 billion for next year, and earnings of $2 billion, the price-earnings ratio of roughly 28 times next year's earnings is a bit too steep. The strategic move to offer complementary food and beverage offerings, and continued store openings will continue to drive topline revenue growth. At the same time I don't expect much more margin expansion after 2014 as these high margins will intensify competition.
I remain on the sidelines, but congratulate management and shareholders on an excellent past quarter.