Starbucks Corp (NASDAQ:SBUX), the world's leading retailer, roaster and marketer of specialty coffee, posted a higher-than-expected jump in quarterly profit last week after new fruit Refreshers, including the new Valencia Orange Refresher, and seasonal Frappuccino iced beverages helped drive more customers to stores in its biggest market, the United States.
The company reported FY3Q13 EPS of $0.55, beating sell-side estimates of $0.53 by 2 cents. Quarterly EPS of $0.55 was also better than the company's guidance range of $0.50 to $0.53. The company's net earnings for the fiscal third quarter increased more than 25 percent to $417.8 million.
Starbucks' 3Q13 was a quarter of very high quality and strong momentum. Global comparable-store sales ("comp") grew by 8%, driven by 7% growth in traffic. Comparable-store sales in the U.S. dominated Americas region grew by 9% vs. consensus estimates of 6.1%. This is relative to peers who have reported 'low-single digit comp.'
The introduction of new flavors to the Refreshers line as well as the introduction of Caramel Crunch contributed to the U.S. comparable-store sales growth. Additionally, food contributed approximately 2% to the comp, and that is prior to the benefits of La Boulange. The broad-based nature of its contributors was exactly the beauty of this comp, as many of these contributors are expected to grow year/year in fiscal year 2014 and beyond.
EMEA comp grew by 2% in the quarter, driven by a 5% increase in traffic. China/Asia Pacific ("CAP") comp grew by 9% in FY3Q13 and traffic growth doubled vs. Q2.
The company expects 4Q EPS to be in the range of $0.59 to $0.60, higher than the previous guidance range of $0.54 to $0.57 and revised consensus estimates of $0.59.
Foods Have Been Phenomenal For Starbucks
In recent months, SBUX has introduced a range of menu items, including salad bowls with flavors such as zesty chicken and black bean. The company has also entered into an agreement with the French food company Danone (OTCQX:DANOY) to develop and sell Greek yogurt in cafes and in supermarkets.
"Foods have been phenomenal for us," Chief Financial Officer Troy Alstead said during an interview. Refreshers energy drinks and macchiato espresso coffees also helped U.S. sales during the quarter, he said.
Currently, food represents approximately 19% of Starbucks' revenue, and contributes 2% of the 9% U.S. comp growth, and this is without any meaningful contribution from La Boulange. In fact, La Boulange is only available in just over 1,000 stores in Northern California and Pacific Northwest markets. The company is on track to bring La Boulange food to more than 2,500 stores by the end of September, including stores in New York, Chicago, Boston and Los Angeles. Over time, the entire U.S. system will have the new food platform, and the long-term target is to generate up to 30% of Starbucks sales from food.
Strategic Agreement with Danone
As yogurt makers and food companies battle for a market share of $7 billion in the U.S. market, SBUX has also jumped into the fray. The company announced last week that it has entered into a strategic agreement with Danone, the world's leading producer of fresh dairy products, to sell a jointly created and developed selection of new, healthy specialty yogurt products through Starbucks cafes and grocery stores.
The strategic agreement with Danone helps address two of SBUX's Chief Executive Officer Howard Schultz's key concerns: offering healthier fare and helping SBUX colonize the grocery store.
Yogurt is one of the hottest products in U.S. grocery stores and there appears to be plenty of room for growth, given that yogurt consumption per capita is far less in America compared with Europe.
According to Euromonitor International, a sales tracking firm, over the last half a decade the U.S. retail market for yogurt has grown at an average of 8.5% per year. Although, the same firm forecasts the growth rate to slow down to 5.9% for the next five years, it is still double the expected growth of packaged food overall.
According to another global information and measurement company, Nielsen Holdings (NYSE:NLSN), sales of all yogurts in the U.S. increased 6.1% to $6.3 billion in the 52 weeks ended June 8,2013; however, sales of the Greek-style yogurt surged 48% to $2.65 billion during the same period.
Greek-style yogurt now makes up more than 40% of the market share. Although General Mills Inc's (NYSE:GIS) Yoplait, which has about one-fourth of the market share, remains the top-selling brand, Danone has a greater overall share between its Dannon, Activia, Stonyfield Farm and Danimals brands, which together account for 30% of the market.
The Starbucks / Danone yogurt products will be sold under the Evolution Fresh name. The first product will be a ready-to-eat Greek yogurt parfait to replace a Greek yogurt with honey parfait currently sold in Starbucks stores. SBUX will start selling the dairy product in its cafes next year and in food retailers in 2015, with global expansion to follow, the company said. Financial details of the agreement were not disclosed.
SBUX's attempt to develop a foothold in the America's booming yogurt market will likely drive long-term growth of channel development and alleviate concern over the segment's recent slowdown in growth.
Coffee prices, which have been falling for the past two years, have been a major source of profit boost to Starbucks as declining costs are resulting in consumers buying more. Arabica-coffee futures are down more than 50% since reaching a 14-year high in May 2011. Over the same period, shares of SBUX surged more than 78% (see chart below). A drop in coffee futures combined with increased sales is providing a boost to SBUX's shares.
According to U.S. Department of Agriculture estimates, global coffee production will exceed demand by 4.46 million bags in the 2013-14 season. It will be the fourth straight year when production will exceed demand, resulting in the highest inventories since 2009.
Strong Balance Sheet
SBUX's balance sheet is also in great shape. The company's debt/equity ratio of 0.10 is significantly lower than the industry average of 1.01. Similarly, the debt/assets ratio of 0.06 is also considerably lower than the industry average 0.35. SBUX has a current ratio of 1.68 vs. the industry average of only 1.23. The world's biggest coffee chain has a debt/EBITDA ratio of 0.19, which is significantly lower than the industry average of 0.91. SBUX's EBITDA/interest and CFO/Total debt ratios of 102.1 and 4.63 respectively are also considerably better than the industry averages of 25.54 and 0.51 respectively.
SBUX is trading at premium valuations; however, we believe the numerous sales and cost drivers including U.S. growth in total employment, food and beverage innovation, lower coffee prices, Europe restructuring, and growth of CPG margin allow the company to trade at premium valuations.
SBUX has a current P/E ratio of 37.2 compared to its own 5-year average of 30.2. The company has a forward P/E of 28.1 and a PEG ratio of 1.4. The company has price-to-book ratio of 10.3 and price-to-sales ratio of 4.0, compared to the industry averages of 7.0 and 2.4 respectively.
Conclusion and Investment Thesis
We have a buy rating on SBUX. Driven by new product innovation, improved cost structure, and improving guest satisfaction, SBUX continues to make progress on its U.S. turnaround. The company's exceptional 9% U.S. comp speaks to the strength of its underlying business, especially in light of the slowdown others have experienced of late. Looking forward, SBUX has an opportunity to build upon this strength by expanding further into food by leveraging the La Boulange platform.
Starbucks is still at an early stage of its international expansion. Driven by implementation of successful initiatives that help turnaround SBUX's domestic business, the company has a long runway for growth at its international business. Goldman Sachs forecasts 8% annual unit expansion at the enterprise level, contributing to double-digit revenue growth for the company. The same firm forecasts emerging market units to account for more than 25% of all units globally by 2016.
SBUX 's Channel Development segment also represents an attractive opportunity for the company to leverage the success of its retail store model and make the brand available through multiple channels both domestically and internationally.
Starbucks should also see meaningful margin expansion in quarters to come as it shifts toward more profitable businesses, benefit from coffee cost deflation and leverage on its strong domestic business.
Bears might argue that SBUX is trading at premium valuations; however, as mentioned earlier the numerous sales and cost drivers including U.S. growth in total employment, food and beverage innovation, comparable-store sales growth, strong domestic business, huge international growth opportunity, lower coffee prices, Europe restructuring, and growth of CPG margin allow the company to trade at premium valuations.