Starbucks Lags Q4 Earnings; Rise In US Traffic Drives Sales

Starbucks Corporation (SBUX - Analyst Report), as expected, recorded softer profits in the fourth quarter of fiscal 2015 than the third due to higher employee and digital investments. Revenues, however, were exceptionally strong driven by another stunning increase in traffic trends in the U.S. – thus ending an outstanding year on a solid note.

The board of directors also approved a 25% increase in Starbucks’ quarterly dividend to 20 cents per share from the current 16 cents.

However, on a slightly negative note, the outlook for the upcoming quarter – the holiday quarter – fell short of market expectations.

Earnings Miss

Adjusted earnings of 43 cents per share missed the Zacks Consensus Estimate of 44 cents by 2.3%. Earnings were, however, at the higher end of management’s expected range of 42 cents to 43 cents.

Earnings grew 16% year over year as solid top-line growth offset lower margins.

Adjusted earnings exclude costs related to the acquisition of its Japanese joint venture (JV), debt extinguishment-related charges and a tax benefit. In fiscal second-quarter, the coffee giant took 100% ownership of its Japanese JV — Starbucks Coffee Japan, Ltd. — per a deal announced in September last year.

Management had warned during the third-quarter conference call that earnings growth will be lower than the third quarter due to relatively higher employee investments, mainly in the U.S.

Strong Sales Growth

Total second-quarter sales of $4.91 billion increased 18% year over year and beat the Zacks Consensus Estimate of $4.89 billion by 0.5% driven by robust comps.

Same-store sales (comps) grew 8%, higher than 7% rise in the previous quarter, driven by increased traffic trends. The comps rise included 4% improvement each in global traffic and average ticket growth.

Higher food/beverage sales, strong comps in the U.S. and Europe and incremental revenues from Starbucks Japan primarily drove sales.

Margins Decline

As expected, adjusted operating margin improved sequentially but declined year over year.

Adjusted operating margin decreased 50 basis points (bps) year over year to 20% due to greater employee and digital investments and dilution resulting from ownership change at Starbucks Japan which offset gains from strong sales and COGS leverage. However, operating margins grew 50 bps sequentially.

Difficult comparisons due to phenomenal profits recorded in the fourth quarter of fiscal 2014 kept fourth-quarter fiscal 2015 margins under pressure.

Segment Details

Americas: Net revenue in this flagship segment rose 11% year over year to $3.38 billion. The increase was attributable to 8% comps growth, same as the previous quarter, supported by 4% increase in traffic. Comps increased 9% in the U.S.

Beverage innovation, higher food sales and continued benefits from digital initiatives led to the solid comps.

Food sales grew 19% year on year and contributed 3% to comp growth backed by strong performance of breakfast sandwiches and lunch offerings.

The beverage platform contributed 6 points to comp growth, driven by new beverages such as Cold Brew as well as strong core beverage performance. Sales of iced beverages, including Teavana Shaken Iced Teas, grew 20% year over year. The limited-time offerings like Pumpkin Spice Latte and Salted Caramel Latte also performed beyond management’s expectations.

Management stated that its latest digital technology, Mobile Order and Pay, is showing positive early results and could prove to be a key growth driver in 2016.

The Mobile Order & Pay service was launched last year and is now available at all company-operated outlets in the U.S. — more than 7,400 locations — and 150 stores in London, U.K. and approximately 300 stores in Toronto, Canada. This initiative allows customers to order before arriving at a Starbucks café and pick up the items at their selected Starbucks store, thus saving time. Management pointed out that it was seeing incremental transactions in U.S. from the initiative, particularly at the busiest stores.

Starbucks started its food and beverage delivery service through its employees at New York’s Empire State building in October. The company also expects to introduce food and beverage delivery in collaboration with on-demand delivery service, Postmates, in Seattle and in other office buildings in New York before the year ends.

In order to expand its loyalty program, Starbucks formed strategic loyalty partnerships with Lyft, Spotify and The New York Times to allow loyalty program members to earn stars through purchases made with these third parties; thereby generating an additional revenue stream.

We believe that digital efforts like mobile order/pay, delivery services and third-party loyalty partnerships, food and beverage innovation, lunch and evening programs, Starbucks Reserve premium coffees and Teavana teas should fuel stronger comp growth in the Americas in fiscal 2016.

Adjusted operating margin improved 40 bps to 24.8% as strong sales leverage and high comps in the U.S. offset employee and digital investments.

Starbucks’ investments in employee welfare include increased pay rates for barista and shift supervisors, additional performance-based recognition programs, new food benefit policies as well as the new online college education program in collaboration with ASU.

Europe, Middle East and Africa (EMEA): Net revenue declined 4% year over year to $308.3 million due to currency headwinds and portfolio shift to licensed stores. Excluding the currency headwinds and portfolio shift, EMEA sales grew 8% driven by strong comps growth.

Comps grew 5%, better than 3% in the last quarter, backed by 3% traffic growth. Every major EMEA market posted positive comps in the quarter, especially the U.K., France and Germany.

Despite a challenging macro environment and currency headwinds, adjusted operating margin increased 510 bps to 17.2%. The improvement came on the back of solid sales leverage driven by a shift to more high-margin licensed stores, and gains on sales of certain assets.

China-Asia-Pacific (CAP): Net revenue soared 110% to $652.2 million driven mainly by incremental $287 million revenues from the acquisition of Starbucks Japan. Excluding Starbucks Japan and currency headwinds, CAP revenues grew 18% on the back of store openings.

Comps grew 6%, much less than 11% in the previous quarter. The comps were entirely driven by increased traffic. Traffic growth in China outpaced that of the segment.

Operating margin at the CAP segment declined 1360 bps year over year to 19.9% due to dilution from ownership change in Starbucks Japan. Excluding Starbucks Japan, CAP margin increased 190 bps backed by strong sales leverage and operating savings.

Channel Development/CPG: This segment includes roasted whole bean and ground coffees, premium Tazo teas, a variety of ready-to-drink beverages (like Frappuccino and Starbucks Refreshers) and Starbucks and Tazo branded K-Cup packs sold through channels such as grocery, specialty retailers, and foodservice to name a few.

Net revenue grew 14% year over year to $456.7 million driven primarily by Starbucks-branded K-Cup offerings and higher packaged coffee sales. Higher K-Cup sales were driven by core product sales as well as strong customer response to new K-Cup products. Foodservice sales grew 8%.

Adjusted operating margin increased 20 bps to 43.2% as higher profits from the North American Coffee Partnership with PepsiCo, Inc. (PEP - Analyst Report) and improved cost of goods sold efficiency offset higher coffee costs and increased marketing expenditure.

All-Other: The segment comprises emerging brands including Teavana (acquired in Dec 2012), Seattle's Best Coffee, Evolution Fresh and Digital Ventures. Revenues in the segment grew 4% to $113.8 million.

Annual Results

In fiscal 2015, total revenue increased 17% to $19.16 billion, marginally beating the Zacks Consensus Estimate of $19.15 billion. The top-line growth topped management’s expectations of approximately 16%. Comps increased 7%, in line with management’s expectation of its growing in the mid single-digit range.

Adjusted earnings of $1.58 per share missed the Zacks Consensus Estimate of $1.59 by a penny but were within management’s expected range of $1.57 to $1.58. Earnings increased 19% from the prior year, at the higher end of management’s expected range of 18–19%.

Adjusted operating margin expanded 50 bps from the last year to 19.1% in fiscal 2015, in line with management’s expectation of modest year-over-year increase.

Fiscal 2016 Outlook

Starbucks issued the fiscal 2016 guidance which was just in line with market as well as our expectations. The fiscal year includes an extra 53rd week.

Starbucks expects revenues to grow more than 10% in fiscal 2016, excluding the extra week. The extra week is projected to add roughly 2% to sales. Currency impact is likely to hurt revenues by 1%.

Comps are expected to grow somewhat above the mid single-digit range. The company expects to open 1,800 stores in the year — 700 in the Americas, 200 in EMEA and 900 in CAP.

For fiscal 2016, the company expects adjusted earnings guidance (including the 53rd week) in the range of $1.87 to $1.89. The earnings guidance was in line with the Zacks Consensus Estimate of $1.88.

The contribution from the extra week is expected to be 6 cents. Excluding the extra week, management expects to deliver earnings growth of at least 15%. This is likely to be offset by a 3% headwind from incremental employee and digital investments and a 2% negative impact from currency.

Adjusted operating margin is expected to increase slightly year over year in fiscal 2016 as strong top-line performance, sales leverage and improved operational efficiency will be partially offset by accelerated global employee and digital investments.

Management expects the employee and digital investments to be between $250 million and $275 million in fiscal 2016, compared to nearly $145 million in fiscal 2015.

Employee investments will include wage and benefit increases and even housing benefits in some countries. Moreover, the company will increase digital investments, both in the U.S. and in its largest international markets in fiscal 2016.

Commodity costs are expected to have a favorable impact on 2016 profits. Starbucks has already locked in about 90% of its coffee costs at favorable prices for fiscal 2016 which should benefit margins in 2016.

Effective tax rate for 2016 will be between 34% and 35%.

First-Quarter Outlook

Adjusted earnings per share are expected in the range of 44–45 cents which fell short of the Zacks Consensus Estimate of 47 cents. Management stated that earnings growth in the first quarter will be lower than full-year growth rate due to relatively higher currency headwinds (will hurt EPS growth by 4 pp) and tougher year-over-year comparisons.

In all the other three quarters, EPS growth is expected at the mid-point of the long-term guidance range of 15% to 20%.

Stocks to Consider

Starbucks carries a Zacks Rank #2 (Buy). Investors interested in the restaurant sector may consider stocks like Bob Evans Farms, Inc. (BOBE - Snapshot Report) and Carrols Restaurant Group, Inc. (TAST - Snapshot Report). Both the stocks sport a Zacks Rank #1 (Strong Buy).