Image Shown: How Starbucks Corporation views its competitive strengths. Image Source: Starbucks – December 2019 IR Presentation
By Callum Turcan
On January 28, Starbucks Corporation (SBUX) reported first-quarter earnings for its fiscal 2020 (period ended December 29, 2019) that modestly beat consensus expectations on the EPS front and matched consensus expectations for its revenues. Shares were broadly flat after-hours and traded down on the January 29 session.
Overview
Same-store sales in the US were up 6% while rising competitive pressures in China limited same-store sales growth to just 3% year-over-year. Luckin Coffee (LK) has been aggressively growing its store count in China, growing from ~625 stores in mid-2018 to 3,680 stores as of its third quarter earnings report for fiscal 2019. Overall, Starbucks’ global same-store sales were up 5% due to higher ticket sizes (300 basis point addition to same-store sales growth) and greater transaction volumes (200 basis point addition to same-store sales growth). Strength in the US was driven in part by the success of its loyalty programs.
Year-over-year, Starbucks’ GAAP revenues grew by 7% to $7.1 billion while its GAAP operating income jumped 20% to $1.2 billion in the first quarter of its fiscal 2020. Margin expansion was driven in part by GAAP gross margin expansion (up almost 130 basis points due in large part to higher selling prices) and controlled corporate-level expenses (G&A expenses were down 3% year-over-year). Starbucks’ diluted GAAP EPS jumped 21% year-over-year to $0.74 last quarter, assisted by its diluted outstanding share count dropping by 5%.
At the end of Starbucks’ last quarter (December 29), the firm was sitting on $3.1 billion in cash, cash equivalents, and short-term investments versus $1.0 billion in debt coming due within a year and $10.7 billion in long-term debt. Given the strength of Starbucks’ free cash flow profile, we aren’t worried about its ability to manage that burden, however, we caution that its net debt load does weigh negatively on its ability to grow its dividend over time.
Guidance and Coronavirus Update
Starbucks maintained its guidance for fiscal 2020; however, the ongoing outbreak of the coronavirus in China is likely to materially hurt its sales in the region and management made sure to highlight that the firm’s guidance for this fiscal year didn’t include the impact from the epidemic. Going forward, the company plans to update its guidance for fiscal 2020 next quarter when more is known about the state of the epidemic. Here’s what management had to say on the issue within the earnings press release (emphasis added):
“The company’s fiscal year 2020 guidance is unchanged from what was provided in conjunction with its Q4 fiscal 2019 earnings report, which excludes any impact of the coronavirus. Currently, we have closed more than half of our stores in China and continue to monitor and modify the operating hours of all of our stores in the market in response to the outbreak of the coronavirus. This is expected to be temporary.
Given the dynamic nature of these circumstances, the duration of business disruption, reduced customer traffic and related financial impact cannot be reasonably estimated at this time but are expected to materially affect our International segment and consolidated results for the second quarter and full year of fiscal 2020. The company will update its guidance for fiscal 2020 when we can reasonably estimate the impact of the coronavirus.”
At the midpoint of management’s guidance before the coronavirus outbreak occurred, Starbucks was targeting for ~12% non-GAAP adjusted EPS growth this year. As of this writing, the outbreak continues to get worse with the number of cases and fatalities growing, and the virus is spreading to other countries as well (however, only China has reported substantial instances of the virus). We are monitoring the situation in China, and hope containment and resolution are quickly achieved.
Image Shown: Starbucks is targeting for high-single-digit, at the midpoint, annual growth in its revenue and operating income. That is expected to result in EPS growth of at least 10% per year, which will be made easier via share buybacks. Image Source: Starbucks – December 2019 IR Presentation
Concluding Thoughts
Starbucks is trading at the upper end of our fair value range estimate, and given the headwinds facing the company in China (in terms of the competitive pressures from Luckin and the ongoing coronavirus overbreak) we see shares as fully valued as of this writing with room for meaningful downside. Its large net debt load is another concern. Shares of SBUX are priced for perfection, but exogenous headwinds could end up derailing its near-term growth trajectory.
Restaurants (Fast Food & Coffee/Snacks Industry) – ARCO DPZ DNKN JACK MCD PZZA SBUX WEN YUM
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Callum Turcan does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.