Starbucks Corporation (SBUX) reported earnings of 43 cents per share for fiscal third quarter 2012, which missed both the Zacks Consensus Estimate of 45 cents as well as company expectations. Starbucks was expecting to post earnings within a range of 44 cents to 45 cents in the quarter.
The lower-than-expected results were due to soft consumer traffic trends in the U.S. in June and a weakening global consumer environment. The company has also been struggling in Europe for some time.
Quarterly earnings, however, increased 19% year over year due to top line and margin growth. Following the third quarter miss, Starbucks reduced its outlook for the fourth quarter due to the economic downturn at large.
Revenues and Margins
Total sales for the third quarter increased 13% year over year to $3.3 billion driven by strong global same-store sales and substantial top-line growth in the Channel Development segment. The quarterly revenues were, however, almost in line with the Zacks Consensus Estimate of $3.31 billion.
Revenues were strong in China, Asia-Pacific and the Americas. Same-store sales, which exclude the impact from new company operated stores opened in the past 13 months, grew 6% benefiting from consumer traffic growth. In the quarter, the company opened 231 net new stores all over the world including the 600th store in China.
Adjusted operating income expanded 22% to $491.6 million while operating margin increased 120 basis points to 14.9%, on the back of top-line growth, partially offset by increased commodity costs, especially for coffee.
Segment Details
Starbucks operates through the following segments: Americas (inclusive of the US, Canada and Latin America); Europe, Middle East, and Africa (EMEA); China-Asia-Pacific (CAP); Channel Development (CD); and Other. The CD segment is not a geographic region but an entirely different channel (referred to as CPG channel henceforth).
The CPG business reflects everything outside the Starbucks stores like packaged coffee, foodservice operations, K-Cups, Starbucks VIA Ready Brew and Tazo tea. The Other category includes Seattle's Best Coffee, Evolution Fresh and Digital Ventures.
Americas: Net revenue in the segment rose 9% over the prior-year quarter to $2.5 billion, attributable to 7% growth in same-store sales and 24% increase in revenues from licensed stores. Consumer traffic trends nonetheless softened in June which has continued into July.
Adjusted operating margin improved 90 bps to 20.7% in the quarter driven by higher revenues which offset the negative impact of rising commodity costs, mostly for coffee.
EMEA: Net revenue rose 9% year over year to $282.0 million in the quarter, mainly due to consolidation of the Switzerland and Austrian markets. The Central and Eastern Europe and the Middle East markets fared much better than those in Western Europe.
Adjusted operating margin declined 100 bps to 0.9% in the quarter due to higher implementation costs incurred for transition to a much more efficient distribution model in the UK. Starbucks hopes to close some stores in Europe in the next few quarters.
CAP: Net revenue jumped 31% to $181.8 million in the quarter driven by a 12% increase in same-store sales, incremental revenue from licensed stores and new store openings. The company has increasingly focused on expanding its business in the fast growing Chinese market which it believes will become its second-largest market by 2014. Same store sales in China grew by double digits in the quarter.
Operating margin at the CAP segment increased 140 bps year over year to 33.8% in the quarter, reflecting revenue growth. However, operating margin was down sequentially.
CPG: Net revenue surged 45% year over year to $316.4 million in the quarter, fueled by meaningful growth in packaged coffee and increasing share of the premium coffee category due to higher sales of Starbucks- and Tazo-branded K-Cup portion packs.
We note, however, that this segment saw a sequential decline in revenue. Adjusted operating margin plummeted 440 bps to 27.3% in the quarter, once again due to higher commodity costs, mostly of coffee.
The premium coffee segment now accounts for more than 50% of the total coffee sold in US grocery, drug, and mass channels. Starbuck owns 28.2% share of premium coffee in these channels. In the premium segment, premium single cup makes up 20% of the market.
Continued growth of its Starbucks VIA Ready Brew and Starbucks K-Cups has allowed Starbucks to capture 22% of the premium single cup market. The Verismo at-home single-cup machine (to be launched in the fall) and the expanded partnership with Green Mountain Coffee Roasters (GMCR) (to use Starbucks-branded Vue packs on the latter’s Keurig Vue single-cup machines) are expected to help Starbucks capture further share of this fastest growing market in the coffee industry.
Cuts Fourth Quarter Outlook
In the fourth quarter, Starbucks hopes to record earnings in the range of 44 cents to 45 cents, down from prior expectations of 46 cents to 47 cents due to challenging economic conditions. This fresh guidance represents an estimated growth of 19%–22%, whereas revenues are expected to grow in the range of 10%–12%. Commodity cost headwinds are expected to wane in the fourth quarter.
Fiscal 2013 Outlook
For fiscal 2013, the company expects revenues to grow in the range of 10%–12% driven by mid-single-digit comparable store sales growth, net new store openings and strong growth in the Channel Development business.
Starbucks is expecting to open 1200 new company-operated stores in 2013, a 20% increase from fiscal 2012. Of the 1200 stores, 600 will be opened in the Americas, 500 in CAP and 100 in EMEA. Of the 500 stores targeted for the CAP region, more than half will be opened in China. Licensed stores will make up between one-half and two-thirds of new store openings in the Americas, EMEA and CAP regions.
Earnings are expected in the range of $2.04 to $2.14, representing growth of 15%–20%. Operating margin is expected to expand 50–100 bps in fiscal 2013 versus the prior year.
Commodity costs are finally expected to be a tailwind in fiscal 2013. Offsetting increased costs of dairy, commodity costs are expected to benefit results by approximately $100 million in fiscal 2013.
Capital expenditures are expected to be approximately $1 billion in fiscal 2013 earmarked mainly for new store openings and manufacturing capacity expansion. The tax rate is expected to be approximately 33% for the year.
Our Recommendation
We currently have a Neutral recommendation on Starbucks. The stock carries a Zacks #3 Rank (Hold rating) in the near term.
Overall, we are encouraged by Starbucks’ strong market standing, new product launches, rapid growth in China and the flourishing CD segment as well as solid turnaround in its U.S. business. However, poor sales in Europe due to depressed macroeconomic conditions and rising cost of commodities, especially coffee, keep us on the sidelines
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