Coffee giant Starbucks Corp. (NASDAQ:SBUX) recently reported financial results for the third quarter of fiscal 2019.
Net revenues increased 8% to $6.8 billion, with adjusted revenues up 11% year over year (two-point headwind from the Nestle (XSXW:NESN) transaction and a one-point headwind from foreign exchange).
Global comparable store sales increased 6%, with an even mix from traffic and ticket. As shown below, this was a standout quarter relative to the 3% to 4% consolidated comp growth that investors have become accustomed to in the past two and a half years:
Comps increased 7% in the U.S., with growth across all dayparts. The improvement was led by beverages (six of the seven points), most notably from premium offerings like nitro cold brew and cold foam. In addition, active rewards members in the region increased by 14% to 17.2 million (loyalty members account for over 40% of Starbucks' business in the U.S.).
In addition to the mid-single-digit comp, global net stores increased mid-single digits to 30,626 locations, with the China store count up 16% year over year (the region accounted for roughly one-third of all net new locations). Based on the company's plan to have 6,000 stores in China by the end of fiscal 2022, that implies a continued store count growth rate of roughly 15% for the foreseeable future.
Here's what CEO Kevin Johnson had to say on the call about recent developments in the China business:
"China delivered a very strong quarter, and we remain bullish on the long-term market opportunity as we deploy capital to build new stores and expand our presence... Much like in the United States, China's comp performance was driven by an enhanced customer experience and beverage innovation. Digital programs, including loyalty and delivery, contributed meaningfully to the quarter's performance as well... Our Digital partnership with Alibaba was also an important driver [and] has enabled us to expand Starbucks Delivers to approximately 2,900 stores across nearly 80 cities. This puts us on track to exceed 3,000 stores or roughly 75% of our total store base by the end of this fiscal year. We continue to see strong performance in key cities, including a meaningful, incremental transaction lift, increased ticket and strong operational performance. In Q3, delivery sales represented approximately 6% of total sales volume... Given these strong early results, we are confident that Starbucks delivers will be an important growth vehicle for our business in China."
The company's non-GAAP operating margin declined 20 basis points to 18.3%. This is reflective of the impact of strong comps on margins in the U.S. and China and the Asia Pacific (up 130 basis points and 120 basis points, respectively), offset by a roughly 70 basis point headwind from Streamline.
Non-GAAP operating income in the quarter was $1.25 billion, an increase of 7%.
All-in, non-GAAP earnings per share were 78 cents, up 26% from the year-ago period. The outsized growth in earnings per share relative to operating income reflects a 12% decline in the share count over the past 12 months, as well as a 3-cent benefit from a discrete tax benefit (adjusted for this item, earnings per share were up roughly 20%).
While these results are clearly impressive, the stock has nearly doubled over the past year. At today's price, the stock trades at roughly 35 times forward (fiscal 2019) earnings.
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 in recent quarters. But with that said, Starbucks will undoubtedly have rough patches in the future, just like it has had in the recent past.
In addition, the company has taken on a lot of financial leverage as of late (it has returned roughly $18 billion to shareholders over the past six quarters, with plans to return another $7 billion between now and the end of fiscal 2020). As it nears the end of outsized capital returns to shareholders, that tailwind will fade.
When it comes to valuing businesses, I like Bill Nygren (Trades, Portfolio)'s idea of uniformly applying a market multiple in the terminal period, with slight adjustments higher or lower when it seems appropriate to do so (some businesses clearly have brighter future with more attractive returns and growth prospects).
Even if Starbucks deserves 20 to 25 times in the terminal period, that's a mid-single-digit annual headwind to compounded return over five to seven years when you're starting from 35 times forward earnings. Said differently, Starbucks needs to deliver strong double-digit growth to get investors back to even (assuming they require a forward rate of return comparable to the historic returns achieved from owning U.S. stocks).
Personally, baking in annualized earnings per share growth in the teens is a tough task as a baseline assumption. For that reason, I'm not interested in buying Starbucks at current levels.
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