Shares of Starbucks Corporation (SBUX) saw a meaningful retreat on Friday after the coffee retailer reported its second quarter results. Shares fell 5% despite the fact that Starbucks beat analysts estimates by a penny.
Second Quarter Results
Starbucks reported an 18% increase in earnings per share to $0.40 compared to $0.32 last year. Consensus among analysts was that the company would report earnings per share of $0.39. Net revenues increased 15% to $3.2 billion as store sales increased 7% driven by a 6% increase in traffic and a 1% price increase. The company opened net 176 stores during the quarter across the globe.
"Starbucks record Q2 performance demonstrates the strength of our business, the increasing power and global relevance of our brand and the success of our unique Blueprint for Profitable Growth business strategy," according to CEO Schultz.
America
The company reported a 10% increase in quarterly revenues to $2.37 billion. Operating income increased 10% as well to $463 million as operating margins improved by 10 basis points to 19.5%. The company opened 76 stores during the quarter. Revenue growth was driven by a 7% increase in traffic and a 1% increase in prices.
Europe, Middle East and Africa
Starbucks reported a 14% increase in quarterly revenues to $272 million. The company reported an operating loss of $5.5 million (2.0% negative margin), compared to a profit margin of 3.2% last year. The company reported strong growth in Austria and Switzerland and in total opened 17 new stores in the region. Margin compression was the result of new regional strategic initiatives.
China and Asia Pacific
Revenues in the Asia Pacific market increased 32% to $175 million as the company net opened 83 new stores. Operating income rose to $69.5 million as gross margins expanded by 660 basis points to 39.8%. Store traffic increased 14% and price hikes of 4% boosted revenues and operating margins.
Channel Development
The "channel development" division focuses on packaged coffee sales of the Starbucks and Tazo branded portion packs. Revenues increased 57% to $322 million. Operating income grew 22% to $81.7 million as operating margins fell 740 basis points to 25.4% driven by higher coffee commodity costs, which had a negative impact of $20 million.
Outlook
The company now expects to open roughly 1,000 new net stores for the entire year which compares to 417 in the first six months. It expects to open 500 stores in the Americas, 400 in Asia-Pacific and 100 in Europe, Middle East and Africa. Revenue growth is expected to come in the low teens driven by mid-single digit comparable store sales growth, new store openings and channel development.
Margin improvement will come in between 50 and 100 basis points driven by slight improvement in Americas, a positive full year Europe, Middle East and Africa margins. Investments and the recession in the region will negatively impact margins compared to last year. China/Asia Pacific margins will come in between 30-35% with Channel Development coming in around 25%.
The company has raised its full year earnings per share target of $1.81-$1.84 which translates into 19-21% year-on-year growth. Easing coffee commodity costs indicate that third quarter earnings per share come in between $0.45-$0.46 and $0.46-$0.48 for the final quarter of the year.
Valuation
The company did not supply a balance sheet within the quarterly report. Therefore I look back to the annual report of 2011 which shows that the company has $2.05 billion in cash, equivalents and short term investments. The company operates with $550 million in long term debt for a net cash position of roughly $1.5 billion. After Friday's correction the company is valued a little over $43 billion which values the operating assets of the firm at $42 billion. At this valuation the firm is valued at roughly 3.6 times annual revenues and about 34 times 2011's annual profits.
Currently the company pays a $0.17 quarterly dividend for an annual dividend yield of 1.2%
Investment Thesis
Despite Friday's pullback long term investors have seen some good returns. Shares have more than five-folded since the beginning of 2009 when shares traded around $10 to levels around $57 at the moment. The return of founder Howard Schultz who got the business back on track and the initiating of a dividend combined with further global growth has spurred operational performance and its share price. Despite the earnings beat shares fell 5% on Friday after shares have already returned 25% since the first of January.
The full year 2012 outlook implies that the annual revenue multiple will come down to 3.2 times while the price-earnings ratio will come down to an expected 31 times. At these levels valuations remain stretched as austerity measures in Europe will continue while the US consumers remain strapped as well as taxes will go up and higher gas prices put pressure on discretionary spending. It remains the question whether new store openings and strong performance in the Asia Pacific region can offset these negative consequences in order to justify such a premium valuation.
At the end of the day I guess that shareholders have priced Starbucks which sells premium priced coffee at a premium priced valuation. While I personally don't mind overpaying a dollar for their coffee, I have more stringent criteria for my investment decisions.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
