This Earnings Report Leaves 1 Question Unanswered

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I'm a pretty logical thinker and when I look at a company's earnings report I like it when things seem to make sense. The good news is, when I read Starbucks (NASDAQ: SBUX) earnings report most of the information was very positive. The bad news is, I got to the end of the report with one major question left unanswered.

There Can Be More Than One Winner
In the coffee and tea markets that Starbucks competes in, I've heard some investors suggest that where Starbucks wins, others lose. I don't believe that is the case at all. While on an individual purchase, if a customer chooses Starbucks over say Dunkin Brands (NASDAQ: DNKN) Dunkin Donuts, there is a clear winner and loser, this isn't like other industries. 

In the coffee and tea industry, I can buy a $4 Starbucks beverage in the morning, and then buy a $2 Dunkin Donuts coffee in the afternoon. I've known some people to use their Green Mountain (NASDAQ: GMCR) Keurig machine in the morning, then stop by Starbucks for a coffee in the early afternoon, and then make a run by McDonald's (NYSE: MCD) for a McCafe beverage in the late afternoon. Each purchase isn't necessarily dependent on the prior purchase. The bottom line is, Starbucks can do well, and so can many other companies.

Is This Growth Enough?
I know there are some old school Starbucks investors looking at the company's current quarter and wondering if this is it? Reporting net revenues up 11% and EPS up 14% should be more than enough, but Starbuck's investors have gotten spoiled over the years. Analysts seem to share this optimism and are expecting over 18.5% EPS growth in the next few years. 

When I look at the companies Starbucks competes with, their growth aspirations are pretty easy to understand. Dunkin Brands is expecting revenue growth of 6% to 8% to help the company generate 15.6% to 17.9% EPS growth for 2013. McDonald's expects that menu expansion, new international locations, and low single-digit same-store sales increases to produce high single-digit EPS growth. Since analysts are calling for 5.1% revenue growth and 8.7% EPS growth, this makes sense. Green Mountain expects sales growth of 15% to 20%, to lead to at least 13% EPS growth, as the company continues to invest for the future.

2 + 2 = 3?
I sort of feel like I'm reading the above equation when I look at Starbucks plans for this next year. The company is suggesting 1,300 new stores will be opened, representing 22% growth over 2012. The company is also suggesting “mid-single digit comps.” Assuming stable pricing and everything else staying the same, this would seem to argue for 22% to 27% revenue growth. I know this is overly simplistic, but 22% plus 5% equals 27%, right? So what is causing Starbucks to suggest revenue growth of 10% to 13%? 

What is even more confusing is the company expects to deliver 15% to 20% EPS growth. On the one hand, the company is going to open a lot of new stores, and have strong comps. On the other hand, their revenues won't reflect this same strength. Yet in the end, the company hopes to deliver good EPS growth?

Clues To The Future And What Investors Should Do
Starbucks clearly sees some pricing pressure in the upcoming year. There just isn't a way that 22% more stores and mid-single digit comp. growth equals 10% to 13% revenue growth, without some pricing pressure. The company seems to understand that their customers may choose cheaper options given the competitive environment. 

The good news for Starbucks investors is, the company still looks like one of the best values in the industry, but the competition is getting tougher. For those who believed Green Mountain's business would die out when their K-Cup patents expired, the 4.6 million new brewers, and better earnings just reported seem to argue otherwise. Green Mountain trades for a forward P/E ratio that is over 35% cheaper than Starbucks, yet both companies are expected to see about the same EPS growth in the next few years.

McDonald's is a harder comparison with 8.7% EPS growth and a 3.25% dividend, compared to over 18% growth and a 1.5% dividend at Starbucks. If any stock can challenge the growth and income combination at Starbucks, it might be Dunkin Brands. Dunkin is expected to grow earnings at 15.4%, and pays an over 2% yield. The big difference is, Dunkin is nearly 100% franchised and has much higher margins than Starbucks. In the end, the industry is highly competitive, and Starbucks growth plans seem to leave investors a little confused. However, if the coffee king can deliver on 15% to 20% EPS growth as promised, 2013 should be another good year for investors.


MHenage owns shares of Green Mountain Coffee Roasters and McDonald's. The Motley Fool recommends Green Mountain Coffee Roasters, McDonald's, and Starbucks. The Motley Fool owns shares of McDonald's 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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