Starbucks: Decaffeinated Earnings, Giant Roasteries And The Potential Of China

| About: Starbucks Corporation (SBUX)

Summary

While the company's earnings increased for full-year fiscal 2017, the stock remains overpriced relative to investor expectations.

Fourth quarter results didn't deliver what was needed to spur on the bulls.

With growth in Asia, I think there remains a route of expansion for the company that can drive the stock.

Last time I covered Starbucks (SBUX), the company was dealing with the fallout of a poor acquisition in Teavana and lower growth than what seemed factored into the stock price. The stock hasn't exactly performed like a dream this year. The fourth quarter didn't deliver much to change that. Net income was relatively flat with a discrepancy in the number of weeks included in the quarter vs. last year. Investors are getting nervous about the lower percentage rates of growth achieved by Starbucks. To that I say, boohoo.

The company is no longer a small, nimble firm. They're big. And when you hit the top of your perspective market, it's a lot harder to induce 10% annual growth. While Starbucks has certainly exhausted itself in much of the US market, I remain bearish on the potential in Asia. I also see the company evolving many of its more lucrative city locations into what can only be described as some form of restaurant hybrid. These "roasteries" are huge, with a plenitude of product offerings. These could be a new source of revenue within the home market, as well as overseas. Couple in the number of stores opening in China, and there's still lots of potential here.

Recently, Starbucks proudly unveiled its new "state of the art" reserve roastery in Shanghai, China. I've seen pictures and some film. The place looks more like the coolest bar in the world rather than a coffee shop. At 30,000 square feet, the roastery has three coffee bars. Regular coffee, gourmet coffee, tea, nitrogen infused tea, in house baked goods, this isn't a cafe, it's a restaurant. This is where I think the company can push higher sales growth.

Large location roasteries like this will do well in big cities. The expanding diversity of their offerings represents what Starbucks needs to focus on moving forward if they wish to keep winning. McDonald's (MCD) has taken up a chunk of the coffee business with its McCafe selections. Starbucks needs to counter that sort of impairment within its marketplace by being diverse. Push their own breakfast varieties. Push their own sandwiches. Make the place about more than coffee.

This Shanghai roastery offers beer and wine. While this trend fizzled in the US, I think the potential of alcohol sales within their planned 30 potential roasteries could work wonders. To give you an idea of the scale of this thing, the roastery can handle a capacity of over 1,000 customers. That's a lot of cash flow if they can make it work. The hype and grandiose offerings of this roastery should provide Starbucks with a testing ground to figure out the best marketing and inventory plans for China.

Total net revenues experienced a 0.2% pullback for the fourth quarter. These revenues of $5.7 billion were accumulated over 13 weeks compared to 14 weeks in 2016. Still, it represents rather stagnant overall sales growth. More troubling is the 16.7% pullback in operating income of $1.02 billion. All this boiled down to 1.6% lower earnings year over year of $788.5 million. Due to share buybacks, those earnings remained level at $0.54 a share.

For the full year, Starbucks delivered 5% sales growth. The $22.38 billion in revenue still didn't counter expense growth, resulting in a 0.9% pullback in operating income. Net income grew 2.4% to $2.88 billion.

Starbucks is opening a store in China every 15 hours. With one of the largest burgeoning consumer bases in the world, there has to be untapped value there. The China/Asian Pacific market had sales growth of 3% in fiscal year 2017. They had the lowest percentage change in ticket transactions though at 1%. This roastery, with its plethora of options and prices, should help drive up transaction prices. The fourth quarter put together a 5% increase in operating income in the Asian theatre. That should continue assuming things like this mega store are a hit.

I view Starbucks as a hold. There's no reason to give up on what has been a pretty lucrative endeavor just yet. There's still a lot of story to be played out in China. The company recently spent over $1 billion to gain control of 1,000 coffee shops in the country. Its Teavanna acquisition has been a bust in America, but Asia has a ton of tea drinkers. I think they could put the brand to good use in this marketplace. The 2%-ish dividend isn't bad either.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.

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