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The Science of Hitting
The Science of Hitting
Articles (607) 

Starbucks: Marching Ahead

A look at the company's first quarter results

February 05, 2020 | About:

Coffee giant Starbucks (SBUX) recently reported results for its first quarter of fiscal 2020.

Revenues for the quarter increased 7% to $7.1 billion, inclusive of two points from streamline-driven activities, most notably the conversion of certain international operations from company-operated to licensed stores. Global comparable store sales (comps) increased 5% in the quarter, with traffic contributing two points and ticket contributing another three points. As shown below, the company has seen results stabilize in the mid-single digits following a few years of comp deceleration:

Comps increased by 6% in the U.S. in the quarter, led by strength in beverages (five points). Notably, as highlighted by CEO Kevin Johnson on the conference call, Starbucks’ comps have outpaced their peers in the restaurant and QSR space in each of the past five quarters. The cold beverage platform continues to lead the charge, with growth in all dayparts and regions in the first quarter. In addition, active rewards members in the U.S. increased in the mid-teens to 18.9 million (up nearly 50% cumulatively over the past three years).

In addition to mid-single digit comps around the globe, net stores increased by 6% to 31,795 locations, with the store count in China up 16% to 4,300 locations throughout the country. Despite the cannibalization headwind from additional units, comps in China were up 3% in the quarter (with traffic and ticket both contributing). The company has seen significant adoption of mobile order and pay, which accounted for a mid-teens percentage of total transactions in the quarter. They also continue to add customers to their rewards program, with the number of members in China climbing 40% year-over-year to 10.2 million.

However, the China region faces some short-term headwinds. As a result of the uncertainty surrounding the Coronavirus, Starbucks announced that they have closed more than half of their stores in China (those closed stores account for roughly 5% of the company’s annual revenues). If these concerns persist, it seems likely to me that the pace of store openings that the company has guided to for fiscal 2020 is likely to be impacted as well.

But, that said, I don’t think this is a material concern for investors. Even if these concerns (and closures) endure for months, I don’t think that has any impact on the company’s long-term prospects. As CFO Patrick Grismer noted on the conference call, “We expect the impact to our business will be temporary. Our brand is very strong in China, and our confidence in the profitability and growth potential of this business is undiminished.”

The company’s non-GAAP operating margins expanded by 80 basis points in the quarter to 18.2%, resulting in a double digit increase in operating income.

Shareholders have benefited from significant (and well timed) capital returns, primarily share repurchases. The impact was notable in the first quarter, with the diluted share count falling 5%. As shown below, the diluted share count at Starbucks has contracted by roughly 20% over the past three years (note that the company has also added roughly $8 billion in incremental long-term debt over that time period). After adjusting for a one-time tax related item, this helped the company deliver a 16% increase in non-GAAP earnings per share (EPS) in the quarter.

Despite the better than expected results, management maintained fiscal 2020 guidance:

“Given the strength of our first quarter results, we had intended to raise certain aspects of our guidance for the full fiscal year. However, as Kevin mentioned, given the extraordinary circumstances that are rapidly developing in China, we are simply reaffirming our original guidance and will provide an update when we have better visibility to the impact of coronavirus. The magnitude of the impact will depend on the duration of store closures as we work with local authorities to manage the situation and protect our partners and customers. At present, we are unable to reasonably estimate the impact to the business.”

Personally, I hope that Mr. Market overreacts to the short-term headwinds that the company is facing. I would greatly appreciate the opportunity to own this high-quality business at a more reasonable valuation. Only time will tell if he’s willing to be so generous.

Disclosure: None

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About the author:

The Science of Hitting
I'm a value investor with a long-term focus. My goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio - a handful of equities account for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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