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Coffee giant, Starbucks Corporation (SBUX - Analyst Report) delivered solid third-quarter fiscal 2013 results, beating the Zacks Consensus Estimates for both revenues and earnings. Both the metrics also grew year over year. Robust increase in global traffic, increasing popularity of its Starbucks loyalty cards, efficiency improvements and cost controls and lower coffee costs boosted profits.

Starbucks’ adjusted earnings of 55 cents per share for the third quarter of fiscal 2013 beat the Zacks Consensus Estimate of 53 cents by 3.8%. Earnings grew 28% year over year and also beat management’s expectations, driven by solid sales performance and significant margin growth.

The company raised earnings expectations for the fourth quarter and fiscal year 2013 and also issued an impressive guidance for fiscal 2014.

Revenues and Margins

Total sales for the third quarter increased 13% year over year to $3.74 billion and also surpassed the Zacks Consensus Estimate of $3.72 billion. Strong comps in the U.S. and Asia-Pacific and significant improvement in Europe drove the top line in the quarter.

Same-store sales, which exclude the impact of the company-operated stores opened in the past 13 months, grew 8%, higher than both the first and second quarter driven by 7% increase in global traffic. Innovative beverages and an expanded food program drove traffic growth.

Adjusted operating margin increased 150 basis points (bps) to 16.4% driven by strong sales leverage and lower coffee costs. Cost controls and improved efficiency in the retail stores also boosted margins.

Segment Details

Starbucks operates through the following segments: Americas (inclusive of the U.S., Canada and Latin America and also includes the La Boulange bakery business acquired in the fourth quarter of fiscal 2012); Europe, Middle East and Africa (EMEA); China-Asia-Pacific (CAP); Channel Development (CD); and Other. The CD segment is not a geographic region, but an entirely different channel (referred to as CPG channel henceforth). The CPG business reflects everything outside the Starbucks’s stores like packaged coffee, foodservice operations, Starbucks coffee and Tazo tea K-Cup packs, Starbucks VIA Ready Brew and Tazo teas. The All-Other category includes Teavana, Seattle's Best Coffee, Evolution Fresh, Tazo Retail stores and Digital Ventures business.

Americas: Net revenue in this flagship segment rose 12% over the prior-year quarter to $2.78 billion, attributable to 9% growth in same-store sales. In Americas, U.S. comps grew a solid 9% despite the cautious consumer spending environment. Growth in the U.S. was driven by continued beverage innovation and enhanced food offerings (especially La Boulange bakery items).

Starbucks loyalty cards have become increasingly popular and are a major driver of consumer traffic in the U.S. In the third quarter, total dollars loaded on Starbucks cards grew 30% year over year in the U.S. We believe that the comps will continue to improve in the U.S. Canada and Latin America also did well in the quarter.

Adjusted operating margin improved 210 bps to 22.3% in the quarter driven by strong sales leverage, improved productivity and lower coffee costs.

EMEA: Net revenue increased 2% year over year at $287.2 million in the quarter driven by improvement in comps. Comps grew 2% in the quarter, much better than the declines witnessed in the past few quarters. Increased consumer traffic at the stores due to food/ beverage innovation and growth in the loyalty program drove comps in the quarter. The company witnessed positive comp growth in the U.K.

Adjusted operating margin increased 260 bps to 3.2% in the quarter due to portfolio-mix shift toward licensed stores and solid cost control.

The company is trying to revive its business in Europe by pursuing increased higher-margin licensing opportunities, shutting down unprofitable stores, cutting general and administrative (G&A) expenses and implementing more robust brand initiatives. We believe these initiatives have started showing fruitful results leading to the improved performance in the third quarter.

CAP: Net revenue jumped 29% to $233.7 million in the quarter driven by 9% increase in same-store sales and the rapid pace of new store openings. Consumer traffic grew 8% in the third quarter, double than that of the second quarter, driven by local innovations as well as growth in core offerings. Japan did significantly well with comps rising in double digits.

Operating margin at the CAP segment improved 250 bps year over year to 36.2% in the quarter, turning around from the declines seen in the past two quarters. Increased operating leverage, higher joint venture income and lower coffee costs drove the profits for this segment. However, CAP margins are expected to decline sequentially in the fourth quarter.

CPG: Net revenue grew 6% year over year to $336.4 million in the third quarter as strong performances of Starbucks/Tazo branded K-Cup portion packs, VIA Ready Brew and Verismo-at-home coffee machine were offset by softness in packaged coffee. K-Cup portion packs sales increased 51% in the quarter.

Revenue growth in this segment has slowed down in this fiscal year due to increased competitive environment for packaged coffee. Starbucks lowered the list price of its packaged coffee products in May in response to price reductions by almost all competitors.

CPG revenues are expected to accelerate in fiscal 2014 driven by volume growth from recent price reduction, innovation, international expansion and an accelerated agreement with partner Green Mountain Coffee Roasters, Inc. (GMCR - Analyst Report). Under the new five-year agreement, Starbucks will triple the number of its products that it supplies to be run on Green Mountain’s Keurig brewers.

Adjusted operating margin increased 280 bps to 28.6% in the quarter driven by low coffee costs.

All-Other: Revenues in the segment grew to $108 million, more than doubling over the last year.

Fourth Quarter & Fiscal 2013 Earnings Guidance Upped

Fiscal 2013 earnings expectations were increased from a range of $22.12 – $2.18 to $2.22 – $2.23.

The fourth-quarter earnings guidance was also increased from 54 cents – 57 cents to 59 cents – 60 cents. The guidance, however, includes a one-time gain from sales of minority stake in joint ventures in Argentina and Chile.

In the fourth quarter, revenues are expected to grow in the range of 10%–13%. The third-quarter comp performance is not expected to be repeated in the fourth quarter and is expected to range between 5% and 7%. Starbucks expects operating margins to improve 100 bps driven by better operating leverage. Lower commodity costs are expected to benefit earnings by 2 cents in the quarter which will be partially offset by the lower pricing for packaged coffee.

Robust fiscal 2014 Guidance Issued

For fiscal 2014, the company expects revenues to grow in the range of 10%–13% driven by mid single-digit comparable-store sales growth and net store openings.

Starbucks expects to open 1400 stores in the year including 600 in America, 100 in EMEA and 700 in CAP.

Operating margin is expected to expand approximately 150 bps – 200 bps year over year. Adjusted earnings (excluding gains from sale of minority stakes in joint ventures in Chile, Argentina and Mexico) are expected to grow 18% – 22% from the 2012 level and range between $2.55 and $2.65 per share. Lower coffee costs are expected to benefit earnings in the range of 9 cents – 10 cents in the year which will be partially offset by the pricing actions for packaged coffee.

Starbucks carries a Zacks Rank #2 (Buy). Other restaurateurs such as Burger King Worldwide, Inc. (BKW - Analyst Report) and Cracker Barrel Old Country Store, Inc. (CBRL - Snapshot Report) are currently doing well and have a bright outlook. Both the stocks carry a Zacks Rank #1 (Strong Buy).

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