Coffee giant, Starbucks Corporation (SBUX - Analyst Report), delivered mixed first-quarter fiscal 2014 results, beating the Zacks Consensus Estimate for earnings but missing the same for revenues as U.S. sales slowed. However, Starbucks raised earnings expectations for 2014 while maintaining the top-line guidance.
The Zacks Rank #3 (Hold) company reported earnings of 71 cents per share in first-quarter fiscal 2014 which beat the Zacks Consensus Estimate of 69 cents.
However, earnings included a gain of 2 cents from a litigation credit. Excluding the benefit, adjusted earnings were 69 cents, in line with management’s expectations (67 cents– 69 cents) and grew 21.5% year over year driven by solid margin expansion.
Revenues and Comps
Total sales for the first quarter were $4.24 billion, missing the Zacks Consensus Estimate of $4.30 billion. We believe the top-line miss resulted from modest comps shortfall in the U.S. as more consumers opted for online shopping this holiday season.
Nevertheless, revenues increased 12% year over year driven by new store openings, strong comps in China/Asia Pacific and Europe and successful food and beverage innovations.
Same-store sales, which exclude the impact of the company-operated stores opened in the past 13 months, grew 5%, driven by 4% increase in global traffic. Comps, however, slowed down from the past two quarters – fourth and third quarters of fiscal 2013.
In the quarter, the company saw a major shift in consumer shopping behavior from store purchases to online purchases.
Though comps slowed down slightly in the first quarter due to lower in-store foot traffic, Starbucks claimed that the quarterly results do not reflect the significant future sales benefit from the new Starbucks gift card activations and Starbucks card reloads in the quarter. Also, Starbucks chief executive officer, Howard Schultz, said that consumers preferred to gift shopping cards instead of a particular item this holiday season. Dollars loaded on the loyalty cards increased an impressive 24% to $1.4 billion in the quarter, suggesting that millions of customers will be visiting Starbucks stores in future quarters thereby boosting the top line. Also, the company processed more than 40 million new Starbucks card activations, valued at over $610 million in the U.S. and Canada alone in the first quarter.
Schultz believes that Starbucks’ strong digital, card, loyalty and mobile capabilities make it one of the very few retailers to benefit from this shift in consumer shopping behavior. The quarter-end deferred revenues rose 29% year over year to over $1 billion due to the rapid pace of Starbucks card loads in the quarter.
Adjusted operating margin increased 260 basis points (bps) to 19.2% driven by strong sales leverage, store efficiency, lower coffee costs and easier year-ago comparisons. Last year, the company incurred costs related to its leadership conference, litigation charges and the impact from Superstorm Sandy which were absent in the first quarter of this year. Strong margin growth in all segments drove profits in the quarter.
Americas: Net revenue in this flagship segment rose 8% over the prior-year quarter to $3.07 billion, attributable to 5% growth in same-store sales. However, comps were slightly lower than the past 2-3 quarters due to the shift in consumer shopping behavior and softening of traffic and comp growth in Dec 2013. Unfavorable weather conditions in December have pressured traffic across the broader retail sector.
Nevertheless, new store openings, higher holiday beverage sales (like pumpkin spice latte and holiday beverage trio) and enhanced food offerings (especially La Boulange bakery items) led to the positive growth in revenues and comps.
Europe, Middle East and Africa (EMEA): Net revenue increased 11% year over year to $339.5 million in the quarter driven by solid comps and store openings. Comps grew 5% in the quarter representing the strongest growth in three years. Increased consumer traffic at the stores due to food/ beverage innovation and growth in the number of licensed stores drove comps in the quarter.
China-Asia-Pacific (CAP): Net revenue grew 25% to $266.9 million in the quarter driven by 8% increase in same-store sales and the rapid pace of store openings. Also, strong brand awareness, innovative product offerings and increased use of Starbucks loyalty cards pulled up the top line.
Channel Development/CPG: This segment includes whole bean and ground coffees, premium Tazo teas, a variety of ready-to-drink beverages, Starbucks VIA Ready Brew, and Starbucks and Tazo branded K-Cup packs sold through channels such as grocery, specialty retailers, foodservice etc.
Net revenue grew 7% year over year to $401.0 million in the fourth quarter driven by strong performances of Starbucks/Tazo branded K-Cup portion packs and strong foodservice sales which offset headwinds from lower pricing on packed coffee. Verismo at-home coffee machine also saw solid holiday sales.
Though fiscal 2013 was slower, CPG revenues and profits are expected to accelerate in double digits 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 has tripled the number of its products that it supplies to be run on Green Mountain’s Keurig brewers.
All-Other: The All-Other segment comprises emerging brands including Teavana (acquired in Dec 2012), Seattle's Best Coffee, Evolution Fresh and Digital Ventures. Revenues in the segment grew to $159.2 million, growing 174% year over year, due to the inclusion of sales from Teavana retail stores which were absent last quarter. Teavana performed strongly in the quarter.
Payment of Kraft Litigation Charge
In the quarter, the company paid its dues to Kraft Foods, Inc. against settlement of the year-long distribution agreement dispute. The indemnity was paid to Mondelez International, Inc. (MDLZ - Analyst Report) which emerged when Kraft Foods was split into two separate companies, Mondelez and Kraft Foods Group, Inc in Oct 2012. This led to the issuance of $750 million of debt in Dec 2013, which brought the total long-term debt for Starbucks at just over $2 billion.
Fiscal 2014 Earnings Outlook Increased
The fiscal 2014adjusted earnings guidance was raised from a range of $2.55–$2.65 per share to $2.59–$2.67 per share to account for the first quarter beat. Excluding non-routine gains and the Kraft litigation charge, this represents 18%–22% growth over fiscal 2013 levels. The earnings growth will, however, be second-half weighted growing approximately 20% in the period.
However, the company continues to expect revenues to grow 10% or higher. Comps are still expected to grow in the mid single-digit range. In addition to food/beverage innovations, loyalty program and single-serve products, we believe La Boulange bakery items, Evolution Fresh juices and Teavana tea could emerge as meaningful top-line growth drivers in fiscal 2014.
Operating margin (excluding the litigation charge associated with the Kraft arbitration) is still expected to expand approximately 150 bps–200 bps year over year driven by higher revenues and lower coffee costs. Earnings are expected in the range of 54 cents–55 cents in the second quarter and 64 cents – 66 cents in the third.
Lower coffee costs are expected to benefit earnings in the range of 9 cents– 10 cents per share in the year which will be partially offset by the pricing actions for packaged coffee. In addition, the company expects incremental interest expense (due to $750 million in additional long-term debt issued in Sep 2013) and higher tax rate in the year compared to fiscal 2013. Tax rate is expected to be approximately 34.5% in the year, higher than 2013 levels.