Starbucks: Shares Will Reach $90

Jul.28.14 | About: Starbucks Corporation (SBUX)

Summary

SBUX reported strong results thanks to increasing traffic, new stores, and the operating leverage that comes with rising sales.

All segments reported strong results, and SBUX is not near saturation anywhere, though China/Asia Pacific likely offers the best long-term growth.

Guidance was also solid given management's traditional conservative approach, and I expect shares to reach $90 within 12 months.

Starbucks (NASDAQ:SBUX) shares fell about 2% on Friday as Wall Street digested the company's quarterly results. In reality, the results were very strong, which is why I remain bullish. The selling on Friday was not due to weak results but probably a bit of profit taking. After all, shares have jumped 10% just in the past three months. While I understand wanting to book a profit, I believe selling SBUX at current levels is short-sighted as the company is still in the middle innings of its growth story thanks to new products, a powerful brand, and a continued international expansion. Under $80, I would be a buyer rather than a seller of SBUX.

In the company's fiscal third quarter, it earned $0.67 on $4.2 billion in sales, which beat by $0.01 and $60 million respectively (all financial and operating data available here). Revenue growth was a robust 11% while expanding margins helped EPS accelerate by 22%. While many of the bears have focused on rising food prices as a major headwind, operating margins jumped 200bp to a Q3 record of 18.5%. This gain in margins can be explained by two factors. First, it hedges much of its commodity risk out beyond a year, which makes commodity price movements far less impactful. Additionally, many expenses like G&A, labor, and rent are essentially fixed costs, irrespective of sales volume. With sales increasing dramatically, gross margins flow almost entirely to the bottom line, helping to boost margins. While sales jumped 11%, costs of sales inclusive of occupancy only rose by 7%, while store operating expenses only increased 8%. Operating leverage is helping to boost margins.

Global same-store sales growth remains remarkably consistent at 6%. For four and half years, SBUX has seen comp growth of at least 5%. In other words, we are not seeing much of a growth slowdown, despite an ever increasing store count. Starbucks is not near saturation in any major market, even though in the US it seems like there is a Starbucks everywhere. In fact, US same-store sales growth was an even faster 7%, thanks to increased traffic, some price increases, and new products. Starbucks opened 344 stores around the world, bringing its count to 20,863. These new stores help SBUX grow revenue faster than same-store sales growth.

If we look around the world, results are strong. In the Americas, it added 149 new stores and comps were up 6%. These factors boosted revenue by 10% while increasing sales leverage boosted margins by 150bp and operating income by 18%. The Americas accounts for nearly 75% of Starbucks' revenue, making it critical for near term results. This unit continue to deliver fantastic results, and with solid same-store growth, it is clear that there continues to be ample room for expansion. Some new offerings, like alcohol in select markets, could help boost sales in non-traditional hours and will help to further accelerate income growth.

With the European economy stabilizing, we are seeing improvement in EMEA. Same-store sales jumped 3%. This unit's revenue is less than 8% of the company's total, so there is the potential to opportunistically expand on the Continent and in select Middle East markets like Dubai. The company did just that, adding 37 stores, helping to boost revenue 13%. Operating margins nearly tripled to 9% in the quarter thanks to lower costs and higher revenue.

China and Asia Pacific continue to be a source of tremendous growth with comps up 7%. New stores accelerated to 160 from 119 last year, reflecting the potential in this market. While revenues are still relatively small at $288 million, they were up 23% year over year, and this region has tremendous potential thanks to a rising middle class and fast economic growth. Within 10 years, I expect China and Asia Pacific to account for at least 15-20% of global revenue thanks to a superior growth rate. In the quarter, CEO Howard Schultz said the company has made a "breakthrough" in China and is becoming a part of the daily morning routine. This should translate to accelerating growth.

Additionally, Starbucks is still a coffee play, but tea is actually a larger global market. Last year, Starbucks acquired Teavana, but it still accounts for less than 3% of all locations. If Starbucks can do for tea what it did for coffee, growth could be absolutely explosive. That is far from certain and there are definitely operational risks, but Schultz has proven it costly to bet against him. Even if Teavana doesn't take off like Starbucks has, there is ample room for growth, and its store count will certainly hit several thousand before the end of the decade, which will provide Starbucks with a very long growth runway. I think SBUX is attractive just on its main business, and Teavana's potential amounts to a free call option in a new market segment that could push growth even higher.

In fiscal 2015, SBUX expects revenue growth of at least 10%. It will open 1,600 new stores (increasing the global count by about 7%), and EPS growth will be 15-20%. Some on the street thought these figures were a bit underwhelming, but management has a history of under-promising and over-delivering. I continue to expect SBUX to grow sales by at least 11% in 2015 and EPS by 18-21% or about $3.20. Under $80, I think Starbucks is attractive and with its long-term growth, it should trade towards $90, which would yield a PEG (price to earnings growth) of 1.5x. Starbucks is still a premiere growth stock, and investors should bet on it.

Disclosure: The author is long SBUX. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.