Starbucks (SBUX) reported quarterly earnings on Thursday that showed strong annual growth but did not beat on all metrics (press release available here). As a consequence, shares were trading near the flat line as investors tried to digest the numbers. While shares are up a solid 34% over the past twelve months, sentiment has been turning more negative over the past three months as investors worry if SBUX has become an expensive stock, fully pricing in future growth prospects. As a consequence, shares are off more than 10% from their 52-week high. After these numbers though, it is clear that investors should be buyers of any further weakness.
In the quarter, Starbucks earned $0.71, which is up from 24.5% from last year's $0.57 figure on revenue of $4.24 billion, up 11.6% from last year's $3.8 billion total. Compared to analyst consensus, earnings beat by $0.02 despite a revenue shortfall of $50 million. Starbucks was able to beat on the bottom line despite a disappointing top line thanks to fantastic margin expansion. Operating margins were up 260bp to 19.2% thanks to lower commodity costs, brisker sales pace, and an absence of non-routine expenses. Overall, global same store sales were up 5% while many were hoping for 5.5% same store sales growth.
Importantly, traffic was not as bad as some had feared. Weak mall traffic was expected to drag on U.S. sales, but U.S. traffic was up a solid 4%. Thanks to a slightly bigger ticket size, same store sales in the U.S. were up 5%. While 4% traffic growth is light compared to past years, it is far better than most retailers and restaurants who had a very challenging holiday season. Overseas traffic growth was also solid. In Europe, the Middle East, and Africa (EMEA), same store sales growth was up 5%, which was the briskest pace in over three years, and traffic was up 3%. It appears that the European economy has bottomed, and consumers on the continent are starting to spend again. I expect a strong 2014 out of this region as the economy exits its death spiral.
China and the Asia Pacific (CAP) remain a major driver of growth for Starbucks with comps up 8% on traffic growth of 7%. Starbucks now has over 4,000 locations in CAP, which accounts for 20% of its global store count. With continued store openings and high sales growth, this region will continue to deliver significant revenue growth. Now in the region, operating margins fell by 330bps to 30.4% driven in large part by a weaker yen. These pressures should dissipate particularly in the back half of calendar 2014.
Importantly, Starbucks is in a position to accelerate revenue growth as existing sales continue to show strong growth trends and the company is more quickly opening new locations. Starbucks opened 142 stores in the US, up 55 from last year's pace. Reflecting a stronger European economy, SBUX opened 64 locations compared to only 7 last year. Starbucks also continues to capitalize on a rapidly expanding Asian middle class with 209 store openings compared to 125 last year.
In fact over fiscal 2014, Starbucks plans to open 1,500 locations, which would increase its store count by 7.5%. This target would suggest a similar pace of store openings over the next three quarters. While much of the focus is on Asia thanks to the growth profile of those economies, Starbucks has massive growth potential in EMEA where it only has 2,000 locations. Starbucks generates roughly 9x as much revenue in the Americas as in EMEA despite the comparable size of both economies. The company is accelerating its pace of store licensing to capitalize on the market potential. Starbucks will be growing for years in this region before getting anywhere near saturation as EMEA could easily house 15,000 Starbucks locations. While the European economies get less attention than Asia, it could drive a similar amount of growth for Starbucks as it expands its relatively small market position.
Management also reiterated and refocused 2014 guidance. Revenue growth for the year will exceed 10% again, and I am looking for a figure closer to 12-13% thanks to mid-single digit same-store sales growth and an increasing store count. Management also expands better margins to persist throughout the year with an expansion of 150-200bps. For the full year, management is looking for EPS of $2.59-$2.67 while the street is looking for $2.66. In the second quarter, EPS will be $0.54-$0.55 compared to estimates of $0.56.
Now, this earnings guidance may seem somewhat underwhelming, but Starbucks has a history of exceeding its expectations and its forecast typically includes a margin of safety to minimize the chance of a miss. With double digit sales growth and expanding margins, I am looking for full-year EPS in the $2.67-$2.75 range, which would represent 20% annual earnings growth. At Thursday's close, shares are trading 27x 2014 earnings, which certainly isn't cheap.
However, I believe Starbucks deserves this valuation given its strong growth and long growth runway. 15-20% EPS growth doesn't mean much if the growth rate is about to rapidly decline. In Starbucks case, it should be able to maintain double-digits growth for many years (at least another 5 years) thanks to its strong position in Asia and significant expansion opportunity in Europe. Further, Teavana is a fast growing brand that will power growth globally as Starbucks adds stores.
Interestingly, if you valued Starbucks based on its locations, it trades at $2.75 million per location, about on par with McDonald's (MCD), which has much less growth. With an increasing store count and same store sales, I think Starbucks should trade at least at a 20% per-store premium to McDonald's, which suggests a share price of $88-$90. Below $75, investors can buy one of the fast growing restaurants in the world at an attractive valuation while receiving a not-too bad 1.4% yield, and management has been growing the payout 20% annually. This quarter confirms the bull case for Starbucks. I would buy on any weakness.