Investors in Starbucks (NASDAQ:SBUX) were slightly disappointed on Thursday following the market close. This came as the company expects its fiscal 2015 earnings to come in at the low end of the long-term targeted growth rate.
Given the high valuation at 30 times earnings and the fact that all signs are positive already, I am worried about which driver could continue to drive momentum forwards. This is despite a relative underperformance of the shares over the past year. I remain cautious at current levels, even as I remain optimistic in the very long run.
Starbucks posted third quarter sales of $4.15 billion, up 11.2% compared to last year, with sales being in line with consensus estimates.
Reported GAAP earnings improved by 22.7% to $512.6 million. Given the relative stable share count, earnings per share rose at a similar pace to $0.67 per share.
Earnings per share were in line or beat by a penny depending on which consensus estimates you were looking at.
A Look Through The income Statement
Overall sales growth was driven by all of its operations in all geographical segments. Most importantly, global comparable store sales rose again by an impressive 6%, surpassing estimates at 5.1%.
Note that most of this growth was driven by strong pricing with prices being up 4%, while the remainder of growth was driven by improved volumes. This strong growth and cost awareness resulted in overall operating margin expansion of 200 basis points to 18.5% of sales.
In terms of the structure of its operations, Starbucks now operates in three main areas. Company-owned stores remain the largest operation, posting a 10.2% jump in sales to $3.29 billion.
Consumer packaged goods and foodservice sales rose by 11.8% to $455.1 million. Revenue growth was most spectacular at the licensed stores which posted a 19.3% jump in sales to $408.1 million.
Despite the overall double-digit revenue growth, total operating expenses were up by just 8.6% to $3.48 billion, driven by a modest pace of the increase in operating and occupancy expenses. As such, operating income advanced to 18.5% of sales, being up roughly 180 basis points compared to last year.
A Look Across The Globe
North America remains of course Starbucks' most important segment as it managed to post 10.1% sales growth to $3.06 billion. Growth was driven by a 6% jump in comparable sales. This implies that Starbucks still relies for nearly three quarter of total sales on its home turf.
The operations remain very profitable as operating earnings expanded again both in absolute and relative terms. Operating income of $728 million results in operating margins of about 23.8% of sales.
Europe, the Middle-East and Africa posted a 12.6% increase in sales towards $323.5 million driven by favorable FX rates, among others. Despite the double digit increase in sales, comparable store sales growth came in at just 3%. Cost cutting and sales leverage resulted in operating income of $29.2 million which more than tripled compared to last year, marking operating margins of 9.0% of sales.
China and the wider Asia-Pacific region continues to be the main driver, posting sales growth of 23.1% to $287.6 million, driven by a solid 7% comparable store sales growth. The unit remains the most profitable segment on a geographical basis, posting operating margins of 35.0%.
Channel development sales rose by 13.4% to $375.3 million, as operating earnings improved by eight percent points to 37.1% of sales. Earnings were driven by higher gross margins after a price hike earlier this year.
Outlook For The Year
Given that this was already the third quarter in Starbucks' fiscal year, the outlook for the year is in essence an outlook for the fourth quarter.
Reported GAAP earnings for the year are anticipated to come in at $2.70 to $2.72 per share. This includes a five cents benefit to earnings which is not recurring. Comparable earnings for the final quarter are therefore seen between $0.73 and $0.75 per share.
For next year, Starbucks anticipates to show revenue growth of 10% or more. This should be driven by net openings of 1,600 stores as well as global comparable store sales in the mid-single digits.
Non-GAAP earnings are seen at 15-20% over 2014s anticipated results, which would imply 2015 earnings of about $3.12 per share.
Valuing The Franchise
Starbucks failed to provide a balance sheet with the third-quarter earnings report, yet the company ended the second quarter with $1.5 billion in cash and equivalents while having $2.0 billion in debt outstanding.
This modest net debt position does not hamper the company in its target to open roughly 4 new coffee stores per calendar day!
For this year, the company is on track to post sales of about $16.5 billion on which it is anticipated to earn $2.66 per share on a comparable basis, or close to $2.0 billion.
Trading around $79 per share in after-hours trading, Starbucks' equity is valued at roughly $60 billion. This values equity in the franchise at 3.6 times annual sales and roughly 30 times GAAP earnings.
A Strong Track Record
Starbucks operating track record and share price performance have both seen divergent trends at times over the past decade.
Between 2004 and currently, revenues have more than tripled to little over $16 billion as discussed above. The company has been able to show significant margin expansion, with earnings roughly five-folding over this time period. Despite the growth, Starbucks managed to reduce its outstanding share base by about a tenth.
It should be said that growth has stagnated around the recession which hurt shares which fell from $40 in 2006 to levels of $10 during the recession. Ever since, share have been on fire, increasing to current all time highs in the low eighties.
Growth has of course been driven by the pyramid of new store openings at a rate of about 7% per annum, comparable store sales growth in the mid to high single-digits, as well as continued margin expansion.
Starbucks continues to move along just fine, predicting another year of double digit growth in revenues next year. Comforting to some investors might be the fact that coffee costs for 2015 are locked in for about 60% at the moment. This is as coffee prices are expected to come in roughly flat compared to 2014 after witnessing a lot of volatility earlier this year.
As discussed above, Starbucks' earnings have been benefiting from new opening of stores, comparable sales growth and margin expansion, which combined have fueled earnings growth. Yet the latter of these earnings drivers, being the margin expansion of operating earnings, is expected to come under pressure a bit. Despite projecting 10% or more sales growth, earnings for next year are seen at the lower end of the 15-20% long-term earnings target.
Investments, not only in new stores, but also in existing store technologies regarding payments as well as new drink machines, are expected to be on the increase. Higher coffee prices as well as worker training and tuition programs are limiting margin expansion for next year.
While I completely appreciate the very strong track record, and underpenetration across the globe versus North America, I am worried about the valuation at 30 times earnings, while operating margins are already very high. While the company continues to move along and innovate by focusing on tea, foods, innovative pay and loyalty programs, I certainly don't see a compelling risk-reward opportunity at current levels.
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