STARBUCKS (SBUX) – UPDATED WRITEUP – INEXPENSIVE RELATIVE TO ALMOST EVERYTHING ELSE!

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STARBUCKS (SBUX) – UPDATED WRITEUP – INEXPENSIVE RELATIVE TO ALMOST EVERYTHING ELSE!

THE COMPANY

Starbucks continues to be the premier roaster, marketer and retailer of specialty coffee in the world. The company operates in 83 markets, up from 81 a year ago. Historically, the sales mix has been 74-75% beverages, 20% food, 4% ready-to-drink beverages (classified as Channel Development income and includes royalties from Nestle under the Global Coffee Alliance) and 1% packaged and single-served coffees and teas.

As of the end of last year, the company operates and licenses approximately 32,500 stores globally.  The company operates 10,109 stores and has licensed another 8,245 in the Americas segment (North and South America). Internationally, the company operates 6,461 (4,700 in China) and licenses another 7,779 (Korea leads with 1,468 stores).  Over the next 18 months, the company plans to close upwards of 800 stores, so net store growth in the coming year will be lower than prior years.

Not surprisingly, the company’s sales and operating profits continue to be dominated by the Americas segment. The spike in operating income attributed to the Channel Development segment in FY20 was due to large declines in the profitability of the other two segments and not an increase in margins. As trends normalize in FY21, the operating income contribution from this segment will revert back to its historical percentage (but is still growing).

Since our last update, Starbucks has issued FY21 guidance as well as hosted its Biennial  Investor Day, which provided long-term guidance through FY24. In this update we will look at the recent guidance and discuss changes in customer behavior in the context of this guidance.

Summary of Fiscal 2021 Guidance

  • Consolidated revenue $28-$29B
    • Global comp sales growth 18-23%
      • Americas comp sales growth 17-22%
      • International comp sales growth 25-30%
        • China comp sales growth 27-32%
      • Consolidated GAAP operating margin 14-15%
      • Non-GAAP EPS $2.70-$2.90 per share
      • Cap Ex $1.9B
      • Guidance for FY22-FY24
      • Non-GAAP EPS growth of 10-12%
      • Revenue growth
        • Company 8-10%
        • Retail Business 8-10%
        • Channel Development 5-6%
          • 2018 Global Alliance with Nestle has performed better than expected.
        • Non-GAAP Operating Income Margin 18-19%
        • Capital Allocation
          • 50% of Earnings Payout Ratio
          • 2% yield
          • 1% Share Repurchase per year
          • 3X leverage
          • Addressable Coffee Market
            • Euromonitor estimates the global coffee market at roughly $360B in 2019.
              • Expects CAGR of 5-6% through 2023.                      This means that the global addressable coffee market in 2023 would be approximately $450B.
    • This growth provides a significant tailwind for Starbucks. As a result of these estimates, the company boosted its global comp growth to 4-5% in FY23 and FY24. This compares favorably to its previous estimate of 3-4% at the 2018 Biennial Investor Day. The estimate for the US was also increased slightly to 4-5% over the same timeframe. Later we will discuss some of the factors in the US that are driving the change.
  • Store format changes
    • Starbucks is starting to shift to focus more on convenience and the store base is expected to change to reflect this.
    • Over the next three years, pickup, drive-thru and other new formats will expand to 45% of U.S portfolio, up 1000 percentage points since 2020.
    • Margin expansion 100-200bps
      • Sales rebound creates natural operating leverage.
        • Mix to more high-volume, high margin drive-thrus leverages labor costs.

    Digital memberships

    • Starbucks has 19.3M 90-day active members in its digital ecosystems.
      • These members drive 50% of total revenue
      • One in every four transactions coming from mobile order and mobile pay.
    • Addressable customer base is close to 75M.
      • Lots of growth potential if the company can add these customers to digital platform.
      • Fiscal    ’16    ’17       ’18     ’19      ’20      Q1’21    FY’21        Long Term
  • Historically, Starbucks has seen modest changes in the total average ticket, driven mostly by price increases and occasionally an increase in food attach rates. However, starting in Q3 FY20, there has been a significant shift in the size of the average ticket. The pandemic has caused a shift in customer behavior. Some of these factors may provide a boost to long-term growth and improved margins. However, we see some potential negatives that are important to consider as well.
  • Factors Driving Lower Transactions, but Higher Overall Ticket.
    • Shift from urban cafes to suburban drive-thrus.
      • Driving the shift is more customers working from home.
      • Urban locations have a higher mix of hot coffee only orders which is a lower average ticket.
      • In suburban locations, customers are purchasing multiple beverages and food items. Customers are ordering for other family members and neighbors that are either working or studying at home.
      • Customers ordering later in the morning. This has helped spread out workflow for baristas and improved operations.
    • Customers are ordering more cold drinks.
      • Cold beverages now account for over $1B in sales and growing.
      • Millennials and Gen Z-ers under 30 year old are twice as likely to drink cold coffee than the average customer.
      • Cold beverages sell at premium prices.
        • For example, customers are ordering more frappucinos and modifiers (ingredients that are added to a basic coffee).
      • Cold beverages are being bought in larger sizes than hot coffee.
    • Customers are ordering more food items.
      • 26% of customers looking for healthy options in both food and beverage.
      • Starbucks continues to innovate with healthy food choices such as the Impossible breakfast sandwich, breakfast wraps and plant-based milk substitute offerings like soy and oat products.
      • As management has often said, “trialing is the start of a routine.” Even as customers return to work in urban areas, we would expect that some customers will continue to order these higher priced items food and beverage items.

    At Biennial Day, the company included this slide to illustrate how the trend towards more pickup and to-go orders will impact the store base. While the number of stores in Midtown Manhattan is expected to remain flat, there is a significant change in the mix to smaller pickup stores. These stores will be less expensive to staff and operate and still generated significant sales, which will increase the company’s long-term return on investment.

These changing trends, if sustainable, could help support the company’s long-term guidance of 4-5% comparable sales growth. Historically, transactions have been relatively and changes in the average ticket have been mostly driven by modest price increases. If the current trends in consumer behavior continue, it should be easier for the company to drive both frequency of visits and higher ticket prices with more food being purchased per order. This will also help leverage labor and operating costs.

THE BUSINESS MODEL IS CHANGING

Starbucks long-term success is more than just the result of selling an addictive product. It created a culture where customers and baristas interacted with each other on a personal level and customers lingered in the stores for hours. These relationships and the in-store experience is one of Starbucks’ greatest competitive advantages. It is possible that the  combination of an increase in drive-thru/pickup, smaller stores and increased digital marketing could hurt brand long term by affecting the relationship between customer and employee.

On the other hand, the higher utilization of the digital app can lower marketing costs and improve the “personalization” of the products, satisfying customers more from that standpoint. A customer’s relationship with the barista may not be what it was, but “the times they are ‘a changin’ and this may be the best approach, all things considered.

OUR CONCLUSION

What other restaurant company would you rather put away for the next five to ten years, with confidence that  earnings and dividends are likely to grow faster than the general economy. The growth as described above will be provided by a combination of (1) reopening of stores and normalization of routines (2) transformation of the asset base (3) accelerating digital momentum (4) easing competitive dynamics, notably in China   (5) franchising or licensing of company stores outside of US (6) continued progress with industry leading Rewards program (7) modest exposure to nationwide $15 minimum wage.

In spite of the pandemic SBUX raised its dividend in 2020 by almost 10%, management has stated that it will pay out 50% of earnings in dividends going forward, and all indications are that this kind of growth can be sustained. A good case can be made that Starbucks equity is a better investment, currently yielding 1.7% and likely to grow over time, than US Treasuries, where you get a fixed 1.4% over ten years but no chance to grow your principal. If SBUX can reach its long-term goal of 10-12% EPS growth, then the dividend should grow at that rate as well and provide investors with an 11-13% annual total return. By our estimate, SBUX could be paying $2.35 per share by fiscal ’23, yielding about 2.3% on today’s purchase. The 10 year US Treasury (today yielding 1.4%) wouldn’t be yielding 2.3% unless the principal was down by about 45%, and there is a good chance SBUX equity could be up in price at that point. That’s a double barreled possible win for SBUX.

For the growth stock jockeys among our readers, Starbucks equity is selling now at the high end of its historical range,  relative to EPS and EBITDA. However, we contend that many other restaurant companies, far less attractive than SBUX  in terms of predictable growth and strong balance sheets are selling even more above  their respective ranges.  We don’t provide relative ratings for restaurant names, and we would rather not single out the least attractive situations. Let’s just say that: other than a few premier companies such as Darden and McDonald’s, adding in perhaps Cheesecake Factory and Texas Roadhouse, there are very few companies that represent comparable value to Starbucks.

Roger Lipton