Starbucks Likely Range Bound After Inconclusive Q4 2019 Earnings

Nov. 22, 2019 7:25 PM ETStarbucks Corporation (SBUX)11 Comments2 Likes
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Summary

  • Starbucks' Q4 2019 earnings were positive enough to help its stock hold key longer trend technical support levels.
  • Starbucks benefitted from easy comparisons in the past two quarters which will reverse in the next several quarters.
  • Operating headwinds will likely slow 2020 earnings growth and put pressure on the stock which is trading at four times growth rates.

After more than doubling from 2018 lows, Starbucks (NASDAQ:SBUX) has undergone extended profit taking in the past three months. From its highs in late July, the stock has corrected by almost 19% following indications 2020 growth rates may slow. Had the company not reported relatively strong fourth quarter 2019 results a couple of weeks ago, investors could have faced further downside as several key technical indicators have already turned bearish. While Starbucks' Q4 earnings may stabilize the stock in the near term above a critical longer-term technical support level, tougher comparisons will require the company to execute almost flawlessly just to match already lowered expectations.

Fourth Quarter And Fiscal 2019 Earnings

In the past two quarters, Starbucks has executed extremely well in their Americas market segment. In the third and fourth quarter, the company reported Americas segment same store sales growth of 7% and 6% respectively. More importantly, transactions were up 3% in each quarter reversing a negative traffic trend during the past three years.

sbux americas(Data compiled from SBUX's quarterly results.)

In addition, the company's second key market China also witnessed strong comparables. China posted comparable same store sales of 6% and 5% in Q3 and Q4, respectively. Again traffic rebounded by 2% in each of the past two quarters after declining in three out of the past four quarters. Increasing delivery trends helped boost results in China while new drinks helped sales in the company's key Americas market.

sbux china sss(Data compiled from SBUX's quarterly results.)

In isolation, comparable same store sales have been strong in the past two quarters. However, as the above charts show, comparable sales were only strong relative to weak results in the corresponding quarters a year ago. 3% traffic growth in the company's Americas region during the past two quarters is very impressive, but it was after an average of -1.5% traffic declines in the same two quarters last year. In fact, even after two strong quarters of 3% traffic growth, traffic volume has only recovered to levels seen three years ago before multiple quarters of declines were recorded. The traffic situation was similar in China as two quarters of decent 2% traffic gains were on the backs of an average of -1.5% traffic declines for similar quarters in 2018.

On a consolidated level, comparable sales grew by 5%. Considering the Americas and China segments represent 87% of the company's store revenues, the lower consolidated average implied that other markets were much weaker. After factoring out China's 5% comparable gains from the international segment's 3% figure, it appears the rest of the world posted flat results at best in the fourth quarter. Perhaps this was part of the reason Starbucks decided to reorganize its operating segments just prior to its fourth quarter earnings release. Even though China segment revenues grew by 4.7% sequentially, the company's international segment combined revenues actually posted a marginal sequential decline during the quarter.

Normally, strong same-store sales, especially those on higher traffic, translate to higher operating margins. Non-GAAP operating margins declined from 18.1% to 17.2% on an annual basis during the quarter based on the company's own non-GAAP definition. While management did explain a couple of factors that accounted for the decline in their Q4 2019 earnings conference call, the CFO had to admit margins were weak relative to comparable sales when asked for clarification.

...admittedly a 20 basis point margin improvement seems very modest in the context of a 5% global sales comp for the quarter.

On an annual basis, non-GAAP operating earnings as defined by the company grew at 2.3% in fiscal 2019. This metric had already hit a wall since fiscal 2017 after extremely robust growth in the years prior. In the past three years, non-GAAP operating earnings have only grown by an average of 2.5%, which is far below the company's 8-10% target highlighted during the company's last annual shareholder meeting. The company's 2020 guidance for operating income did interestingly remove the 'non-GAAP' description, so it will be interesting to see how Starbucks manages to expand margins in 2020.

Non-GAAP Operating Income Non-GAAP Operating Income Growth Non-GAAP Pre-tax Net Income Non-GAAP Pre-tax Net Income Growth
FY 2013 $2,458.70 23.10% $2,498.20 23.06%
FY 2014 $3,063.30 24.59% $3,044.90 21.88%
FY 2015 $3,655.60 19.34% $3,653.10 19.97%
FY 2016 $4,232.10 15.77% $4,218.80 15.49%
FY 2017 $4,412.50 4.26% $4,426.30 4.92%
FY 2018 $4,457.40 1.02% $4,414.50 -0.27%
FY 2019 $4,560.00 2.30% $4,325.50 -2.02%

(Data compiled from SBUX's quarterly results. All dollar figures in millions of USD.)

As the above table shows, Starbucks' pretax net income fared worse than its reported non-GAAP operating income in the past two years. As I noted in my previous SBUX article, the company has funded large share buybacks through debt. Increasing net interest expenses have caused pretax net income to fall below non-GAAP operating income in the past two years. Lower share counts through buybacks did counteract stagnant income levels and resulted in earnings growth on a per share basis.

Outside of the positive comparable sales in the quarter, most of the company's operating metrics were uninspiring. Coupled with fourth quarter earnings that only matched expectations on less than 1% revenue beat, it was not surprising the stock quickly gave up its post earnings pop to close flat relatively by the end of the day.

2020 Earnings Estimate

For 2020, Starbucks expects revenues to grow 6-8% with moderate margin expansion. Other key earnings factors include an even larger interest expense of $415-425 million which would represent about a 27% annual increase. In addition, the effective tax rate is also expected to rise to 22-24% from the 19.5% reported in 2019. These higher non-operating costs will result in slower earnings per share growth of approximately 7% at the midpoint of the company's $3.00-3.05 annual non-GAAP EPS guidance.

Based on the company's current operating metrics and annual guidance using midpoint ranges, the following is a general earnings profile for Starbucks' fiscal 2020.

  • Revenues: $28,364.20
  • Non-GAAP Operating Margin: 17.20%
  • Non-GAAP Operating Income: $4,878.64
  • Other Income: $100.00
  • Interest Expense: $420.00
  • Non-GAAP Pretax Net Income: $4,558.64
  • Tax (23%): $1,048.49
  • Non-GAAP Net Income: $3,510.15
  • Diluted Share Count: 1200
  • Non-GAAP EPS: $2.93

(All dollar figures and share count in millions.)

To reach the company's midpoint $3.025 in annual non-GAAP EPS, Starbucks would need to expand non-GAAP operating margin by slightly over 50 basis points. Based on reported results in the past couple of years, I am not sure how this will be managed unless comparable sales remain extremely strong similar to levels reported in the past couple of quarters. As I noted in my previous SBUX article, the previous estimates appeared aggressive and have ultimately been lowered in the past couple of months. I still believe the current already lowered estimates are still aggressive in light of the company's Q4 earnings release. Either Starbucks would need to hit the debt market again to buy back even more shares, or everything would need to go just about perfectly for current EPS targets to be achieved.

Part of the difficulty in regaining higher margins reported in past years is due to increasing depreciation and amortization expenses. Starbucks has been on an extremely aggressive expansion schedule in the past couple of years. As a result, depreciation and amortization expenses as a percentage of total revenues have increased by almost a full percentage in just the past two fiscal years.

The only way to counter this expense is to grow gross profits at a faster pace. While results in the company's Americas segment have been very strong, other markets, excluding China, have been contracting even despite physical growth in stores. Even in China, revenues have not grown to the same degree as the company's aggressive expansion.

The following table shows China segment results which became available at the start of fiscal 2019. In the past three quarters, annual revenue growth in China has not kept up with store count additions. Starbucks also started delivery services in China since the start of the fiscal year and reported 6% and 7% of total China segment revenues from delivery sales in Q3 and Q4 2019, respectively. Excluding delivery contributions, revenues only grew at a fraction of store growth.

China Revenues China Y/Y Revenue Growth China Store Count China Y/Y Store Count Growth Delivery Ratio Revenue Ex. Delivery
Q2 2019 $702.80 9.00% 3789 17.00% 5.00% (EST.) $667.66
Q3 2019 $728.80 10.00% 3922 16.00% 6.00% $685.07
Q4 2019 $763.00 14.00% 4125 17.00% 7.00% $709.59

(Data compiled from SBUX's quarterly results. All dollar figures in millions of USD.)

While there should still be delivery upside in China, the magnitude left may not be very high. Starbucks' main Chinese competitor Luckin Coffee (LK) posted 12.8% delivery sales during the same quarter, but its delivery sales have been on the decline by design to reduce delivery subsidies that lower store operating margins. Starbucks already noted that while delivery adds to revenues, the profit profile is lower. As a result, incremental delivery sales may not be as accretive to earnings as the increases in revenues suggest. It is due to lower returns on investment capital in markets outside the Americas segment that will make it difficult for Starbucks to fully compensate higher levels of depreciation recorded in the past two years.

Final Thoughts

Technically speaking, the stock has broken two key long-term trendlines (represented by the blue and purple lines in the weekly chart below) that date back to 2018 lows.

sbux weekly(SBUX weekly chart with MACD indicator.)

The daily chart shown below more clearly defines these trendlines as well as key 50 and 200-day exponential moving averages. It should be clear SBUX has been in a downtrend since breaking its 50-day EMA with successive lower highs and lower lows. The 200-day EMA remained a critical support level which held and was helped by the company's recent positive Q4 earnings report. With company specific news unlikely to come out for the rest of this year, SBUX may be range-bound between its 200-day EMA and its 50-day EMA or purple uptrend line.

sbux daily(SBUX daily chart with MACD indicator.)

Beyond the remainder of 2019, the outlook for the stock should be increasingly more difficult. The US and global economies have been showing signs of slowing down. With the current global economic expansion past the decade mark, macro-economic risks only increase with time. As a consumer discretionary company, Starbucks could face greater pressure in an economic downturn after being so aggressive with expansion and share repurchases which helped contribute to the higher debt levels.

Even without a recession, higher debt in a slowing economy may make it more difficult for the company to continue with the high magnitude of share repurchases that led to double digit EPS growth of recent years. If Starbucks can hit its midpoint non-GAAP EPS growth target of 7% in 2020, the stock is currently trading at almost 28x forward earnings. By historical valuation metrics, SBUX is trading at a high premium to growth and as I have argued discount a lot of risk linked to the company's exposure in China.

In my opinion, Starbucks already made a mistake by increasing exposure in China a couple years ago when some US peers had divested exposure ahead of President Trump's escalation of trade tensions with China. Instead of scaling back, the company doubled down by accelerating its physical presence even as a serious Chinese domestic competitor emerged. This all in attitude could prove disastrous if the current trade war escalates to full scale decoupling, but the Chinese consumer's perception of the US would likely hold Starbucks' fate more so than even a worse case political outcome.

This article was written by

Investing Hobo profile picture
3.23K Followers
I am generally a long term investor looking for macrotrends which I believe may play out over the course of several years. While I look at a lot of varying criteria in researching potential investments, I'm more aligned with the analytics involved with investing. Although it's not always a sureguard in shorter time frames, I believe over the longer course of time, valuations and earnings power always determine the path stocks trade. As such, I am value driven and look more at companies trading at discounts to growth rate and earnings power, especially if it's currently being discounted by the market. While I track many different industries, I'm currently have a China centric focus believing the long term macro trend of its population entering the middle class is in its early cycle. As China's gdp per capita increases, discretionary buying power among its middle class should increase at a higher exponential rate. As a result, larger well known companies are poised to profit from this cycle. In addition, I may focus much of my writing on the solar sector for a few key reasons. First the solar sector is widely misunderstood. Second, many companies which operate within the sector are extremely transparent in operating structure. Lastly and more importantly I believe in the longer term prospects for the industry because the economics can be justified when looking at longer trend patterns.
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Disclosure: I am/we are short SBUX. 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: I am also long LK.

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