Can you Make Bucks with Starbucks?
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Starbucks (NASDAQ: SBUX) has been a fascinating growth story during the years I've followed the company. Initially, the company was an effectively managed growth company. The stock was as close to a sure thing as you could ask for. For a while the company seemed to have lost its way, but it has gotten back on track recently. In the company's most recent earnings results you can see the strength of the company's brand, especially in the international division. In a strange twist, apparently the results were less than expected and the drop in the stock seems to represent a good buying opportunity for long-term investors.
With overall revenues up 13% and EPS up 19%, most companies would be more than satisfied with these numbers. However, investors have come to expect a lot from Starbucks and the company's guidance certainly did not help. In its industry, Starbucks dominates in both size and brand name, yet they face increased competition from both Green Mountain Coffee (NASDAQ: GMCR) and Dunkin' Brands (NASDAQ: DNKN).
Where Green Mountain is concerned, many have made a big deal about the company's impending patent expirations on K-cups. However, considering the company directly owns many of the most popular K-cup brands, this may be less of an issue than most people expect. In addition, both Starbucks and Dunkin Brands have already signed deals to co-market their K-cups along with Green Mountain. Starbucks has also committed to produce Starbucks-branded coffee pods for Green Mountain's new VUE system.
While it's true that Starbucks will introduce its own Verismo system, I believe investors should focus less on one appliance and more on the opportunity for Starbucks to expand its traditional locations. This is a differentiating factor between Starbucks and Dunkin Brands. While Starbucks has over 17,000 coffee houses worldwide, Dunkin' Donuts has roughly 10,000 locations. In addition, Starbucks expects to open about 7% more locations in the next year, while Dunkin' Donuts is only forecasted to grow new locations by about 5%. Since Starbucks operates multiple divisions, let's look briefly at how each performed this last quarter.
The company's largest store presence is the Americas segment with over 12,000 locations. While the company only opened 83 new locations in the last quarter, revenues increased 9%, comparable sales increased 7%, and operating income was up 14%. In addition, the company managed to grow its operating margin to over 20%.
On the international front, Starbucks operations in Europe, the Middle East, and Africa showed decent revenue growth, but terrible problems with operating income. Specifically, the company's operating income in this division decreased 47% primarily due to transitioning to a consolidated food and dairy distribution model in the U.K.
The company is calling for 600 new locations in the Americas and 100 new locations in Europe, the Middle East, and Africa. If Starbucks executes on this plan, these two divisions will see total new store growth of around 5%. While these two divisions will grow new stores by a modest amount, the company is planning significant store growth in its fastest-growing markets.
In the China and Asia Pacific division, the company is on fire. Revenues increased better than 30%, comparable sales were up 12%, and operating income jumped 37%. In addition, in this region the company posted a huge operating margin of 33.8%. It makes sense that the company would spend the most money opening new stores in China and Asia Pacific. Starbucks plans on opening about 500 stores in this region, representing nearly 16% new store growth.
The other divisional star for the company was the Channel Development segment, which sells K-cups and prepackaged coffee. This division reported revenues up 45% and operating income increased by 25%. While operating margin fell by 4.4%, this was heavily impacted by coffee input prices. In addition, one could assume that the growth of this channel is good news for Green Mountain. Starbucks specifically said this revenue “increase was primarily due to sales of K-cup portion packs and growth in packaged coffee sales.” As you can see, Starbucks is benefiting from its relationship with Green Mountain, and its international expansion specifically in the China and Asia Pacific markets. What's ironic is even with these two divisions performing well, the company's guidance disappointed investors.
Starbucks' projected revenue growth of between 10% and 13% for both the fourth quarter and full year 2013. While the company's fourth-quarter target seems to be very close to existing estimates, the EPS range for next year was below estimates. That being said, at worst the company would see earnings growth of 14%, and at best growth could come in at nearly 20%. As the company expands its location count in its fastest-growing markets, one would expect the overall growth rate to increase.
For long-term investors, the temporary setback in the stock seems a bit shortsighted. The other options in this industry are either a turnaround opportunity in Green Mountain or a slower growing Dunkin Brands. Green Mountain sells for a forward P/E ratio of under 8 and yet is expected to grow at over 30% for the next few years. While there are concerns about patent expirations, even if the company grew at half the rate analysts expect, the stock appears too cheap to ignore. Since Dunkin' Brands sells for about the same forward multiple as Starbucks, and yet is expecting to open fewer stores and is forecasting lower same-store sales, there's really no question that Starbucks is the better option between these two. I believe there's room for growth for all three companies in the coffee segment, but given the Starbucks' greater presence, higher growth rate, and more stable operations, it could be the best opportunity for investors at this time.
MHenage owns shares of Green Mountain Coffee Roasters. The Motley Fool owns shares of Starbucks and has the following options: long DEC 2012 $16.00 puts on Green Mountain Coffee Roasters and short DEC 2012 $21.00 calls on Green Mountain Coffee Roasters. Motley Fool newsletter services recommend Green Mountain Coffee Roasters and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.