Coffee giant Starbucks (SBUX) recently reported results for the second quarter of fiscal 2020.
For the quarter, revenues declined by 5% to $6.0 billion, with comparable store sales (comps) down 10% on a 13% decline in transactions, partially offset by a low-single digit benefit from higher average ticket. The double digit decline in comps was largely due to weakness in the International segment (comps -31%), most notably in China (comps -50%), offset by less severe declines in the Americas (comps -3%). As expected, Covid-19 and subsequent shutdowns led to widespread closures and declins in traffic.
The difference between comps (-10%) and revenues (-5%) was attributable to mid-single digit growth in units, with the company ending the quarter with more than 32,000 locations globally.
As shown below, these results mark a significant deceleration from the company’s historic results.
As noted on the conference call, comps in the United States were up high-single digits through most of the quarter until the final three weeks of March. Currently, roughly 50% of company-operated and licensed locations in the U.S. are closed, along with more than 75% of locations in Canada, Japan and the United Kingdom. In addition, even for the stores that remain open in the United States, Starbucks reported that they have seen comps decline by roughly 25% throughout April. This implies that overall U.S. system revenues in recent weeks have declined by roughly 60%.
The Americas segment accounts for more than three-quarters of the company’s revenues for the quarter. Looking ahead to the third quarter, that clearly suggests more pain on the horizon. As noted during the call, management expects the negative financial impacts to be “significantly greater” in the third quarter than in the second quarter.
The one region that has returned to something resembling normal operations is China, where 98% of the company’s stores are open (albeit with modified schedules and limited cafe seating). Even there, management expects comps to decline 30% in the third quarter and to be flat in the fourth quarter, with full year 2020 comps down 20%. This points to a reality that I think we’ll see in other parts of the world as well: just because stores reopen does not mean that consumers will immediately return to the routines and spending habits that existed before the pandemic.
As a result of the material sales deleverage experienced during the quarter, operating margins declined by 660 basis points to 9.2%. In the International segment, Starbucks reported a small operating loss, compared to more than $200 million in operating income in the year ago period. Overall, this led to a nearly 50% year-over-year decline in non-GAAP earnings per share (EPS) to $0.32 per share.
Starbucks shareholders benefited in recent years from capital returns, most notably share repurchases, which continued in the first half of fiscal 2020, with $1.7 billion spent on repurchases. As a result, the diluted share count had declined by more than 5% year-over-year through the second quarter. However, the pace slowed; following $1.1 billion of repurchases in the first quarter, the company bought back $600 million in the second quarter. Personally, I think this reflects both the weakening underlying results in the core business as well as the company’s financial position (roughly $10 billion in net debt at quarter's end). Starbucks had a lot of loan money at their disposal a few years back, and they used it.
They’re not in that position anymore. As Chief Financial Officer Pat Grismer put it on the call, “the cash flow implications of these near term operating results are very material.” It will also lead the leverage ratio to climb above management’s targeted range. To address this, the company has suspended its repurchase program, which may be in effect through 2021.
Conclusion
At $77 per share, Starbucks trades at a high-20’s multiple on trailing earnings. We’re in the middle of a period where the company is still facing massive declines in business volumes in its two most important geographic regions (the U.S. and China). In addition, the tailwind previously enjoyed from outsized capital returns will be nonexistent over the next few quarters.
It will be a tough skate for Starbucks in the coming months, and maybe longer. As always, I have no idea what the stock price will do in the short-term. I would love the opportunity to own this high-quality business at a cheap price. For what it’s worth, I think the stock would need to fall precipitously from current levels before it met that description.
Disclosure: None
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