Starbucks is Firing on All Cylinders But Shares Are Expensive

Starbucks (SBUX) reported excellent fiscal first-quarter results Thursday but its outlook fell below optimistic consensus forecasts. We don’t expect to make a material change to our $38 per share fair value estimate.

Total revenue in the quarter expanded 16% to a record $3.4 billion on the heels of strong global comparable same-store-sales growth of 9% (7% increase in traffic and a 2% increase in the average ticket price). Same-store-sales growth was also 9% in the Americas region during the period, while it was only 2% in EMEA (Europe, Middle East, Russia, and Africa) as a result of softness in Europe. During the quarter, the company opened 241 net new stores globally and has now reached 500 stores in mainline China and Latin America. Consumer Products Group (CPG) revenue jumped an impressive 72% thanks to the launch of Starbucks- and Tazo-branded K-Cup packs.

Consolidated operating income jumped 10.8% from the same period a year ago, as expansion was mitigated by an 80 basis point decline in the firm’s operating margin driven by higher commodity costs (primarily coffee). This was quite prominent in the firm’s CPG, where operating margins contracted a whopping 12.7 percentage points. We think coffee costs will continue to be the main driver behind Starbucks effective execution on the bottom line, particularly with respect to CPG performance. Diluted earnings per share in the quarter grew 11% to a record $0.50, beating consensus estimates.

Looking ahead to 2012, Starbucks is targeting the opening of about 800 net new stores globally, with half of them in the Americas, 300 in China and Asia Pacific, and the balance in EMEA. The coffee giant expects to achieve 10% revenue growth and mid-single-digit comparable store sales growth–two targets we think are achievable. Investors should also expect continued expansion in the firm’s CPG business, but coffee costs will ultimately determine whether such significant expansion will fall to the bottom line. We’re skeptical that Starbucks will achieve full-year operating margin improvement of 50 to 100 basis points due to the complexities involved with rapid store expansion and commodity cost pressure.

Starbucks upped the lower end of its full-year fiscal 2012 earnings per share guidance range, which now stands at $1.78 to $1.82 (slightly lower than consensus), representing 17% to 20% growth over fiscal 2011. However, we caution investors that such expansion will be significantly back-end loaded during the year, which opens up the potential, in our opinion, for a downward earnings revision mid-year if the firm’s fiscal third quarter and fourth quarter do not look like they will shape up as planned. All things considered, we’re fans of Starbucks and its future potential, not only in expanding Starbucks locations but also with opportunities presented by its Consumer Products Group (namely K-Cups). However, with the firm trading near $50 per share, Starbucks’ shares are not cheap. We’d wait for a better opportunity before opening up a position in the coffee giant.