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Starbucks (SBUX) Rides on Robust China Comps Amid Margin Woes

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Zacks Equity Research
·5 min read
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Shares of Starbucks Corporation SBUX have gained 21.6% in the past six months, compared with the industry’s growth of 9.8%. The company is gaining from robust China comparable store sales. Moreover, faster-than-anticipated sales recovery in the United States and menu innovation continues to drive growth. However, contraction in margin and high debt remain concerns. Let’s delve deeper.

Key Growth Drivers

China is a major market for the company. After reporting comps decline in second, third and fourth-quarter fiscal 2020 in China on account of the coronavirus pandemic, it returned to growth in first-quarter fiscal 2021 and posted an improvement of 5% (including 3% VAT benefit). In fiscal 2021, the company anticipates China comps to be 27-32% year over year. In first-quarter fiscal 2021, the company opened 160 new stores. In the past 12 months, the region has witnessed store growth of 13%. It is worth mentioning that the company has forayed into 15 new cities in China, and each of those stores are doing outstanding business.

Moreover, robust digitalization in China has been contributing to growth. In China, the company’s delivery program is available in 85% of its stores. Moreover, Starbucks Now Mobile Order & Pay services is available across 99% of its store base in the country. In first-quarter fiscal 2021, China’s 90-day active members rose 14% in fourth-quarter 2020 to 15.4 million, reflecting growth of 51% year over year.

Starbucks sales have been impacted by the coronavirus pandemic. However, the company is witnessing faster-than-anticipated sales recovery in the United States. In first-quarter fiscal 2021, comps fell 5% in the United States, compared with a decline of 9% in fourth-quarter fiscal 2020. The company is optimistic about achieving full sales recovery in the United Sates by the end of second-quarter fiscal 2021. Transaction volumes in the United States continue to witness sharp improvement. The company anticipates global comparable sales to increase between 18% and 23% in fiscal 2021. Moreover, it anticipates Americas and U.S. comparable store sales to increase in the range of 17% to 22% in fiscal 2021. International comps for the fiscal 2021 are expected to be 25-30%.

The company is strengthening its product portfolio with significant innovation around beverages, refreshment, health and wellness, tea and core food offerings. Starbucks is leaning toward fast-growing categories like Cold Brew, Draft Nitro beverages, and plant-based modifiers, including almond, coconut, and soy milk alternatives. Its recent collaboration with Beyond Meat to roll out a plant-based lunch menu in the China is a testament to the same. Now Starbucks customers can enjoy pastas and lasagna made utilizing Beyond Meat's plant-based beef products. It will also include meatless pork alternative known as Omnipork and popular non-dairy milk called Oatley. The new menu is available at more than 3,300 Starbucks locations in China. Both the companies have already partnered to roll out a plant-based sandwich to Canadian locations.

Concerns

Margin contraction remains a major concern. Although margin expanded improved in first-quarter fiscal 2020, it declined in second, third and fourth-quarter 2020. On a non-GAAP basis, operating margin contracted 660, 570 and 400 basis points in second, third and fourth-quarter 2020, respectively. In first-quarter fiscal 2021, on a non-GAAP basis, operating margin came in at 15.5% compared with 18.2% in the prior-year quarter. The downtrend can be attributed to sales deleverage, growth in wages and Americas store portfolio optimization expenses.

Maintaining liquidity has become a herculean task for every company during the pandemic. Starbucks’ high debt remain a concern. The company’s long-term debt increased to $14,673.5million (as of Dec 27, 2020) from $14,659.6 million at Sep 27, 2020. Notably, its times-interest-earned ratio of 2.8 reflects decline from 3.7 in the fourth quarter. This indicates reduced relative freedom of the company from the constraints of debt. Moreover, the company ended first-quarter fiscal 2021 with cash and cash equivalent of $5.2 billion, which is not enough to manage the high-debt level. At the end of first-quarter 2021, the company had debt-to-capital ratio of 1.98, compared with 1.91 at the end of fourth-quarter 2020.

Starbucks, which shares space with McDonald's Corporation MCD and Yum! Brands, Inc. YUM, carries a Zacks Rank #3 (Hold).

A Key Pick

A better-ranked stock worth considering in the same space includes Jack in the Box Inc. JACK, carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Jack in the Box has an impressive long-term earnings growth rate of 17%.

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