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Neutral on Starbucks

Zacks Equity Research

We have maintained a Neutral rating on Starbucks Corporation (SBUX) following appraisal of fiscal second quarter 2012 results.

Starbucks’ second quarter 2012 earnings of 40 cents per share beat the Zacks Consensus Estimate by a penny. Quarterly earnings increased 18% year over year driven by a solid top line, improved efficiencies and cost control.

Revenues increased 15.0%, driven by strong global same-store sales and substantial top-line growth in the Channel Development (:CPG) segment. The company also raised its fiscal 2012 outlook due to improving business trends and strong first half results.

Starbucks is one of the most recognized coffee brands in the world. Other than fresh, rich-brewed coffees, Starbucks’ offerings also include many complementary food items and a selection of premium teas, sold mainly through the company’s retail stores. Popular company brands include Starbucks coffee, Tazo Tea, Seattle's Best Coffee and Starbucks VIA Ready Brew.

Starbucks’ CPG business, which reflects everything outside the Starbucks stores like packaged coffee, foodservice operations, K-Cups, Starbucks VIA Ready Brew and Tazo tea, is growing rapidly. It is a largely diverse (in terms of revenue mix), high margin, high return on capital business which has given a fillip to both top- and bottom-line growth in the past few quarters.  The company expects this business, which deepens Starbucks’ presence in the at-home coffee and away-from-home coffee segments, to continue to grow over the long term.

Starbucks focuses on brand innovation and new products to create differentiated value proposition for its customers. Among the recently launched products Starbucks VIA Ready Brew and Starbucks K-Cups helped it to capture 21% share of the premium single-cup market against a zero presence in this segment just 2-3 years back.

The upcoming launch of the Verismo system and the expanded partnership with Green Mountain Coffee Roasters (GMCR) (to use Starbucks-branded Vue packs on the latter’s Keurig Brewers) are expected to help Starbucks capture further share of this potential $8 billion market in the coffee industry.

Other successful recent product launches include Starbucks Refreshers, made from real fruit juice and green coffee extract, Blonde Roast coffee and Evolution Fresh juices. Continued innovation and new product offerings would drive both top- and bottom-line growth for the company, going forward.

Moreover, Starbucks’ U.S. operations have witnessed a substantial turnaround since the last couple of years. The segment regularly posts an operating margin of around 20% which is expected to improve further through new store openings, remodeling of existing stores, new product launches like Blonde Roast, Verismo, K-Cup, VIA single serve and Evolution Fresh juices over time. Further, Starbucks' business in China is rapidly growing and the region is expected to become the company’s second-largest market by 2014.

Despite the positives, 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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