Coffee giant Starbucks Corporation (SBUX) announced strong third-quarter fiscal 2014 results beating the Zacks Consensus Estimate for earnings and meeting the same for revenues.
However, shares fell in after-market trading following the company’s announcement at the conference call that rising commodity prices and investments in technology will hurt profits in fiscal 2015.
Third-Quarter Earnings
Adjusted earnings of 67 cents per share in third-quarter fiscal 2014 beat the Zacks Consensus Estimate of 66 cents by a penny. Earnings also exceeded management’s expected range of 64–66 cents and grew 22% year over year driven by strong global revenues, aggressive operating margin expansion and share buybacks.
Revenues and Comps Grow
Total third-quarter sales of $4.15 billion were in line with the Zacks Consensus Estimate. Revenues increased 11% year over year as all the segments did well in the quarter.
Same-store sales (comps) grew 6%, driven by 2% increase in global traffic and 4% average ticket growth. Despite difficult consumer spending environment, Starbucks’ 18 consecutive quarters of 5%-or-greater global comp growth is commendable.
Successful beverage and food innovations, better-than-expected U.S. comps and record sales in the Channel Development segment were the primary drivers of comps and revenues.
Margins Remain Strong
Adjusted operating margin increased 200 basis points (bps) to 18.5% driven by strong sales leverage and favorable commodity costs. Margins expanded in all the operating segments, except China/Asia Pacific.
Segment Details
Americas: Net revenue in this flagship segment rose 10% over the prior-year quarter to $3.06 billion, attributable to 6% growth in comps. In the U.S., comps grew 7%, beating management expectations on the back of food sales.
Expanded food offerings — breakfast sandwiches, new lunch sandwiches and premium priced La Boulange bakery items — and innovative beverage products — Teavana Oprah Chai, Teavana Shaken Iced Tea, Fizzio handcrafted sodas — boosted comps in the quarter. Food contributed an impressive 2 points to comps growth in the third quarter. Drive-through stores where sales grew in the double-digit range have been an important contributor to the top line.
Revamped lunch offerings, evening sales of wine and beer, Fizzio sodas, Teavana teas and new digital initiatives are expected to drive comps in the U.S. in the upcoming quarters.
Europe, Middle East and Africa (EMEA): Net revenue increased 13% year over year to $323.5 million in the quarter driven by currency tailwinds, better in-store execution and improved food program. However, despite growing 3% in the quarter, comps slowed down from 6% increase seen in the last quarter. U.K. and Germany did well in the quarter.
China-Asia-Pacific (CAP): Net revenue grew 23% to $287.6 million in the quarter driven by 7% increase in same-store sales (due to increased traffic) and the rapid pace of store openings. Innovative, locally relevant food and beverage products were the key driver of comps in the quarter. While China outperformed in the quarter, traffic declined in Thailand due to political instability.
Channel Development/CPG: This segment includes whole bean and ground coffees, premium Tazo teas, a variety of ready-to-drink beverages, Starbucks VIA Ready Brew, and Starbucks and Tazo branded K-Cup packs sold through channels such as grocery, specialty retailers, foodservice etc.
Net revenue grew 13% year over year to $375.3 million in the quarter driven by increased sales of Starbucks/Tazo branded K-Cup portion packs and higher volumes of packaged coffee in the U.S.
All Other: The All-Other segment comprises emerging brands including Teavana (acquired in Dec 2012), Seattle's Best Coffee, Evolution Fresh and Digital Ventures. Revenues in the segment grew 3% to $109.6 million driven by higher sales of emerging businesses like Teavana and Evolution Fresh.
Fiscal 2014 Earnings Outlook Tightened
The fiscal 2014 adjusted earnings per share guidance was tightened from a range of $2.62–$2.68 to $2.65–$2.67. The guidance excludes benefit from a litigation gain and projected benefit from the sale of retail operations in Australia and Malaysia that may close in the fourth quarter. This range represents 21–22% growth over the fiscal 2013 levels. The fourth-quarter range was also tightened from 71–75 cents to 73–75 cents (excluding the previously mentioned retail operations sale) representing a year-over-year growth of 22% to 25%.
However, the company continues to expect revenues to grow 10% or higher. Comps are still expected to grow in the mid single-digit range.
Starbucks expects to open 1,550 stores in the year, up from 1,500 expected previously as it plans to open more stores in the Americas. The company now expects to open 650 stores in the Americas, instead of 600 expected previously, 150 in EMEA and 750 in CAP.
Operating margin is now expected to expand approximately 200 bps year over year up from 175–200 bps range due to higher profit expectations from the CPG segment. Operating margin in the segment is now expected to increase approximately 600 bps versus 550 bps as expected previously. Higher revenues and lower coffee costs are expected to drive margins. Operating margin guidance excludes the litigation charge associated with the Kraft Foods Group, Inc. (KRFT) arbitration.
Fiscal 2015 Outlook Soft
Starbucks expects revenues to grow 10% or higher. Comps are expected to grow in the mid single-digit range. The company expects to open 1,600 stores in the year — 650 in the Americas, 150 in EMEA and 800 in CAP.
However, management stated that fiscal 2015 adjusted earnings growth could be at the lower end of the long-term target of 15–20% which increased investors’ concern. Rising coffee costs and incremental costs associated with digital initiatives are expected to pressure profits next year.
Commodity costs are not expected to be a tailwind in fiscal 2015 like the previous two years. With coffee prices rising sharply this year, management expects commodity cost to be roughly neutral or have a slightly unfavorable impact in fiscal 2015. With roughly 60% of its coffee needs for FY15 locked at favorable prices, we believe management lacks visibility on coffee costs for fiscal 2015.
In fact, Starbucks recently raised the prices of some packaged coffee and in-store beverages following a similar action by other coffee players — Kraft and The J. M. Smucker Co. (SJM). The companies are raising coffee prices in response to increasing green coffee costs. Coffee prices are at a record high so far this year due to the increasing prices of Arabica coffee since January as a result of drought in Brazil which produces about one-third of the world’s coffee.
Starbucks carries a Zacks Rank #2 (Buy). A better-ranked stock worth considering in the restaurant industry is Chipotle Mexican Grill, Inc. (CMG), which sports a Zacks Rank #1 (Strong Buy).
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