Last week, Starbucks (SBUX) posted a decent earnings report, beating the Street's estimate of 39 cents/share by a penny (earnings call transcript can be read here). The market responded negatively, however, as high commodity costs and lagging European sales were cause for concern among followers of the global coffee retailer and contributed to Starbucks' guiding down its EPS estimate slightly for FY 2012.
Starbucks shares fell more than five percent on the news. In an article recently (Earnings Letdowns: 3 Stocks To Buy Post-Pullback), we profiled Starbucks as one stock to buy on a post-earnings pullback, along with Baidu (BIDU) and Bank of America (BAC). Our conviction in Starbucks in the wake of a disappointing earnings report stems from the fact that its extraordinary growth story has neither changed nor reached any form of a plateau - and, if anything, its recent earnings report only propelled the prospects of its growth. The pullback in our view is more a short-term respite from a sky-high 30%+ gain YTD than a fundamental shift in the stock's momentum.
We see several tailwinds catapulting share price higher in the future, and we've elaborated on those tailwinds below.
The Global Growth Story Remains Intact
Outside of Europe, where sales were down 1%, global growth was quite strong for Starbucks in the first quarter of 2012. EPS beat by a penny, revenue was up 15% Y/Y and at $3.20 billion beat estimates by $20 million, comparable store sales were up 7%, traffic was up 6%, operating income increased 14% Y/Y, and consolidated operating margin remained steady at 13.5%. Those results are extremely strong, and particularly given the lowering EPS guidance for the year, a pullback in share price presents an opportunity to accumulate while expectations are low but solid growth is still occurring.
Asia Sales Are Strong
One of the biggest take-aways from Starbucks 1Q2012 earnings report was evidence of explosive growth in the China/Asia Pacific region. Sales in the region were up an impressive 18%. Given the growing strength of the Starbucks brand in Asia, Starbucks is increasing its targeted new store openings in Asia this year to 400 from 300, with half of expected openings coming in China. Little needs to be written about the growth potential for Western brands in China - and Starbucks has proven itself in the region - but Yum! Brands (YUM) stands as a pointed example of such success.
Starbucks' Instant Serve & Single-Serve Businesses Are Heating Up
There is reason for shareholders to be excited about Starbucks' recent entry into the instant serve and single-serve market. Its Via and K-cup packs have been successful, and the company announced it will be introducing single-serve espresso and brewed coffee to China in 2013, complete with its Verismo home brewing machine. As Starbucks expands its lines of single-serve coffee and rolls out its Verismo home brewing machine, we expect the coffee giant to continue to eat away at competitor Green Mountain Coffee's (GMCR) market share, particularly given its global brand strength and built-in distribution network. Already, Starbucks estimates that K-Cup sales will contribute between $0.03 and $0.05 to FY 2012 EPS, and we see even greater potential in this business segment in the near future.
Starbucks remains an attractive global growth story. Prior to announcing earnings, its stock may have been due for a correction after gaining more than 30% YTD, but its results were quite solid in many regards, particularly given rising commodity costs and deteriorating conditions in Europe. Investors should note the declining sales in Europe as an indication that Starbucks is not immune to the economic troubles of the region. Yet, impressive growth in China/Asia Pacific and its new and exciting business segments, including instant and single-serve coffee, more than compensate for the doubts surrounding the global macro landscape.
Trading at 34 times current earnings and 25 times forward 2013 earnings, Starbucks may not be a value play, but we feel its growth justifies its valuation. Further, the company boasts a strong balance sheet and a price/book ratio of 5.5, as well as a price/sales ratio of 3.6, that we believe are reasonable.
Additionally, we feel that concerns surrounding competitors tend to be overstated. While McDonald's (MCD) poses some threat with its lower priced McCafé division, as does Dunkin Brands Group (DNKN), Starbucks has proven itself to be a lifestyle brand, not unlike NIKE (NKE), Apple (AAPL), or Marlboro/Altria (MO), that offers products that people will buy at a slightly higher price point than competitors. We view Starbucks' competitive position as strong.
We believe Starbucks' recent pullback in share price post-earnings presents an opportunity for investors who had been waiting on the sidelines for an attractive entry point to accumulate.