Latte Lawsuits, Brexit and the Second Quarter. Starbucks (NASDAQ:SBUX) was in the news recently after it was accused of deliberately under-filling its latte orders. This is the second time in the past year that the Seattle-based coffee chain was accused of engaging in questionable in-store practices. However, these developments are expected to be of little impact financially, even though it is certain to garner popular headlines.
The bigger news surrounding Starbucks is the effect of Brexit. With 870 stores, the United Kingdom is Starbucks' largest market in Europe by far. Germany, its second-largest market has a relatively paltry 158 stores. An economic slowdown - by one estimate, the United Kingdom's economy is expected to be 6% smaller by 2020 as a consequence of leaving the EU - is certain to impact customers' willingness to spend their discretionary income on espressos and mochas, particularly with unemployment predicted to climb to 6%.
Brexit occurs against the backdrop of Starbucks' fair fiscal 2016 second quarter earnings. During this period, the company managed to meet analyst earnings estimate of 39-cents per share despite a challenging retail environment. Starbucks reported 6% revenue growth backstopped by a 2% rise in comparable store sales and a 4% increase in per-ticket orders. Following this, the company raised its full-year earnings guidance by a penny and now expects to earn between $1.88 and $1.89 per share.
Dividend Impact and Outlook. Starbucks currently pays a 20-cent per share dividend, which translates to a 1.43% dividend yield at its current market price. Thus, dividend-focused investors who buy Starbucks shares today can expect to earn at least $143 in passive income each year. Starbucks has a fairly solid track record of paying dividends, having paid one each quarter since April 2010. During this span, the company has raised its per-share dividend six times.
We believe that the impact of Brexit on Starbucks' ability to pay dividends will be negligible and may even represent an opportunity to buy the stock at a lower price, thereby raising its industry-leading dividend yield. Here's why:
First, Starbucks' balance sheet is fairly robust. To be sure, the company's unadjusted Working Capital ratio of 0.89-to-1.00 is a bit lower than the industry average - but this is mainly due to the recognition of customers' stored-value card credits worth $1.2 Billion as a liability even though these will ultimately be recognized as sales. Stripping this sum out of the calculation, Starbucks' Working Capital ratio is actually a very healthy - and above-average - 1.23-to-1.00.
Meanwhile, Starbucks' leverage ratio of 1.46-to-1.00 (which is just 1.22-to-1.00 if we subtract its stored-value card liability) is less than half the leverage ratio of its industry peers. It also has little financial debt, with gearing of just 56-cents for every dollar of equity.
What these balance sheet ratios tell us is that Starbucks has both the ability to withstand macroeconomic shocks like Brexit - and the capacity to continue paying dividends. Indeed, in addition to declaring a 20-cent per share cash dividend to investors, Starbucks also announced that it had received approval from its Board of Directors to repurchase an additional 100 million shares, bringing its total available shares for repurchase to 125 million. This is not the action of a company that is facing financial distress.
Second, the United Kingdom's contribution to Starbucks' sales - and therefore its cash flow - is relatively small. The EMEA region, which includes the UK, produced just 5.4% of Starbucks' net sales in its fiscal 2nd quarter. That's less than half the contribution of Starbucks' China/Asia Pacific operations, which accounted for close to 14% of its net sales during the same period. In fact, EMEA's contribution to Starbucks' revenue was equivalent to less than 10% of that of its operations in the Americas - and was also below that of Starbucks' Channel Development/Licensing operations, which accounted for over 9% of Starbucks' net sales during its 2nd quarter.
The reality of the matter is that EMEA is Starbucks' smallest regional market and also its slowest-growing, adding just 1% in the second quarter. Indeed, a Brexit-induced recession in the Europe that caused its EMEA net sales to decline by 15% would only cause Starbucks' overall sales to drop by around 1%. This relatively small decline could conceivably be made up for by even average growth in the Americas and the China/Asia-Pacific regions, which have been the engines of Starbucks' growth in past years.
Third, even if growth in other markets failed to overcome a decline in Europe, Starbucks has been carefully managing its overhead. To wit, despite single-digit revenue growth, Starbucks' operating income rose by 11% to a 2nd quarter record of $878 million. Consequently, its operating margin now stands at 17.3% -- far better than the average operating margin for its industry. To the extent that Starbucks is able to reduce its operating friction, it will continue to increase the cash flow available to its shareholders.
The only question that remains is whether now is the time to buy Starbucks shares or not.
Currently residing around 1.5%, the dividend yield is more than 25% higher than 5 year average of 1.2%. Not bad for investors. But there could be even stronger yields for those that dollar average into the position. Even before Brexit, the prospects for the summer months were gloomy. The fallout from the United Kingdom's leave vote will only raise market volatility considerably in the coming months, presenting multiple opportunities to buy Starbucks shares at a lower price.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SBUX over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inform dividend investors. This article was written by Jonathan Lara, one of our Senior Analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article. Company financial data is taken from the company’s latest SEC filings unless attributed elsewhere. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.