Coffee giant Starbucks (SBUX, Financial) recently reported results for the fourth quarter of fiscal 2019. For the year, revenues increased 7% to $26.5 billion, with adjusted revenues +10% (two point headwind from the Nestle (NSRGY, Financial) transaction and a one point headwind from foreign exchange).
Global comparable store sales (comps) increased 5% in the quarter and for the year, with traffic and ticket both contributing to growth. As shown below, the 2019 result was a nice improvement after a few years of deceleration from the mid-single digit comps that we saw through fiscal 2015:
Comps increased by 6% in the U.S. in the fourth quarter, with traffic growth across all dayparts. The two-year stacked comp, up 10%, was Starbucks best performance in more than two years. The comp growth was led by beverages (five points), most notably from premium offerings like Nitro Cold Brew. In addition, active rewards members in the region increased by 15% to 17.6 million, up nearly 50% cumulatively over the past three years.
Here’s what CEO Kevin Johnson had to say about the company’s success at home:
“The Growth at Scale agenda really is about delivering predictable, sustainable growth - and to do that we've really sharpened the focus on the elements that Roz mentioned and are executing with discipline. So, if you look at the three initiatives that we prioritized for this: (1) elevate the experience in our stores, (2) drive relevant beverage innovation for our customers, and (3) grow digital customer relationships. Those three things are what's driving all-time highs in customer connection scores. That in turn is driving traffic growth. And those same priorities that we focused on throughout 2019 will be the same ones we continue to drive in 2020. And that's part of what gives us confidence that we are pushing on the right elements that differentiate the Starbucks brand versus alternatives in the market, strengthens the connection between our partners and the customers, and in turn drives traffic and growth.”
In addition to global mid-single digit comps, store locations increased by 7% in 2019 to 31,256, with the store count in China up 17%. The company added more than 600 new stores in China in 2019 and now has more than 4,000 locations throughout the country. The overall growth rate was on pace with what we’ve seen in recent years, with a trailing five-year compounded annual growth rate of roughly 8% (with the Americas up 5% per annum and International up 13% per annum).
Despite the headwind associated with sales cannibalization as you add new units, comps in China were up 5% in the fourth quarter (with revenues up 18%). As President of International John Culver noted on the call, “what we’re seeing in China is a direct result of the digital footprint that we’ve been able to build there”. Mobile Order / Pay and Delivery, which Starbucks launched in the region earlier this year, accounted for 10% of their business in the fourth quarter. They’ve addressed a customer need and are reaping the fruits from investing in these new channels.
The company’s non-GAAP operating margins in 2019 declined 80 basis points to 18.3%. After adjusting for the impact of Streamline, the cost of the leadership conference and the benefit from stored value card breakage (both not a few other investments that I view as recurring), I estimate that apples-to-apples operating margins contracted by 30 basis points for the year. If you accept my adjustments, operating income (EBIT) increased by roughly 5% in 2019.
Shareholders have benefited from significant (and well timed) capital returns, primarily share repurchases, with the diluted share count falling nearly 12% in 2019. This benefit, along with a lower tax rate, led to mid-to-high teens increase in diluted earnings per share for the year.
While we’re on the topic, it’s worth noting that the significant decline in the share count over the past few years has been largely attributable to incremental leverage (as has the $7.15 billion that Starbucks received from Nestle as part of the Global Coffee Alliance). As shown below, the company’s long-term debt balance has increased materially over the past five years. While this has been a tailwind as of late, it will impede their ability to take similar actions in the future.
Looking ahead to 2020, management expects continued low-to-mid single-digit growth in same-store sales. After accounting for new unit growth, this should result in a mid-to-high single-digit increase in revenues, with operating margins expected to “improve modestly” across all regions. Finally, after accounting for a headwind from tax related items, management expects a comparable increase in profitability, with earnings climbing to more than $3 per share.
Conclusion
This is a high-quality business with very attractive returns on invested capital. In addition, management deserves kudos for the strong results they’ve delivered as of late, which reflects both operational excellence and intelligent strategic decisions.
With that said, I think the company will face their fair share of rough patches, just like they’ve had in the (recent) past. That’s the reality of running a business. In addition, they’ve taken on significant debt to fund capital returns and are at the high end of their own leverage target.
For those reasons, I am not drawn to the stock at these levels. I would like to buy it at the right price, but I don’t think we are there currently. For now, I’ll keep watching from the sidelines.
Disclosure: None
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