Starbucks - No Triggers For A Short-Term Rebound

Jul.27.12 | About: Starbucks Corporation (SBUX)

Starbucks (SBUX) the roaster and retailer of coffee reported a disappointing third quarter earnings report after the close on Thursday. Starbucks is the third major food and beverage company to report disappointing earnings after McDonald's (MCD) and Chipotle Mexican Grill (CMG) already fell after publishing their quarterly reports over the last week. Currently shares of Starbucks trade 10% lower in after hours trading around $47 per share.

Third Quarter Results

Starbucks reported a 13% increase in net revenues to $3.3 billion for the third quarter, driven by a global comparable sales growth of 6%. Operating income rose 22% to $492 million as operating margins expanded by 120 basis points to 14.9%. Earnings per share rose 19% to $0.43 per share, compared to last year's earnings of $0.36 per share. Earnings per share fell short of the $0.45 expected by analysts, triggering a sell-off in after hours trading.

During the quarter the company opened net 231 new stores, compared to 155 in the third quarter of 2011.

CEO and chairman Howard Schultz commented, "Despite coming short in our expectations I am pleased with the increasing operating leverage we are seeing, the fact that this was our 11th consecutive quarter of record results and the fact that we achieved the results in face of high legacy commodity costs and challenging economic and consumer headwinds in key markets."

Segmental Information

Starbucks reported a 6% increase in comparable sales growth driven by a 5% increase in the number of transactions and the remainder in price growth.

Americas

The North American division reported a 9% increase in revenues to $2.47 billion, driven by a 7% increase in same store sales growth. Average selling prices were up 2%, while the number of transactions was up by 5%. The company net opened 83 new stores which boosted revenues as well. Operating profits grew 14% to $512 million as margins expanded by 90 basis points to 20.7% as a result of operating leverage.

Europe, Middle-East and Africa

The EMEA division reported a 9% increase in revenues to $282 million, driven by expansion in Suisse and Austria, partially offset by the effects of a strong dollar. Operating income fell to $2.6 million as margins compressed by a 100 basis points to 0.9%, as a result of higher distribution costs in the UK.

China, Asia-Pacific

Revenues in China and the wider Asia-Pacific region rose 31% to $182 million as the company opened another 112 new stores during the quarter. Operating income rose 37% to $61.4 million as margins expanded by 140 basis points to 33.8%. Strong comparable sales growth of 12% boosted the results. Transactions rose 8% on the year while prices rose another 4%.

Channel Development

The company's channel development division reported a 45% increase in revenues to $316 million, driven by sales of Starbucks, Tazo and K-Cup packaged coffee. Operating income rose merely 25% to $86.5 million as margins compressed by 440 basis points to 27.3% as a result of higher coffee commodity costs.

Outlook

For the fourth quarter of 2012 the company expects to generate revenue growth between 10 and 12%. Earnings per share are expected to come in at $0.44-$0.45, up 19-22% from last year's non GAAP earnings. Analysts were not impressed as they were expecting Starbucks to guide for fourth quarter earnings of $0.48 per share.

For the full year of its fiscal 2013 Starbucks expects to generate 10-13% in revenue growth. It expects to earn between $2.04 and $2.14 per share, up 15 to 20% from its expected annual 2012 earnings. Again the forecast fell short of anticipations as the street was looking for a guidance around $2.29 per share.

Additionally, the company anticipates to open another 1,200 new stores, the majority in the Americas and Asia-Pacific. Operating margins are expected to expand by another 50 to 100 basis points.

Valuation

Starbucks ended its second quarter with $2.2 billion in cash and short term investments and operates with $550 million in long term debt for a net cash position of roughly $1.6 billion.

Starbucks generated $9.93 billion in revenues for the first 9 months of the year, putting it on track to generate north of $13 billion in annual revenues. The company reported operating income of $1.48 billion, or $1.33 per share for the first nine months of the year. At this rate the company is on track to generate annual earnings of $1.77-$1.78 for 2012.

Based on a 10% price decline in after hours trading the market values the firm at roughly $36 billion, or $34 billion for its operating assets. This values Starbucks at 2.6 times annual revenues and 26 times annual earnings. Currently the company pays a quarterly dividend of $0.17, for an annual dividend yield of 1.3%

Investment Thesis

The wider fast food industry has seen a great couple of years. Starbucks has been no exception, especially not after founder Howard Schultz returned to the company. Shares five-folded from their lows of $10 at the end of 2008 to $60 by April this year.

Until today's report shares traded with year to date gains of 14% which are now largely erased after the drop in after hours trading towards $47 per share. This marks a 25% correction from April's all time high of $62 per share.

Valued at 23 times 2013's expected annual earnings, there are few short term triggers for a quick upwards rebound as consumers are limiting their discretionary spending on a global scale. McDonald's and Chipotle Mexican Grill already warned about the impact of lower consumer confidence and higher food inflation. Both trends seem to be confirmed in Starbucks report today as the firm was forced to issue a disappointing outlook.

For those investors who want to invest in the global fast food and drink industry I would favor a long position in McDonald's. Although its comparable sales growth was only 4%, compared to Starbucks' 6%, it trades at merely 16 times earnings. Furthermore it pays a much more generous dividend yield. At these levels the risk-reward ratio for Starbucks is not very favorable.

Disclosure: I am short CMG.