Tag Archives: SBUX

STARBUCKS – (SBUX) – UPDATED WRITEUP – STILL A GREAT COMPANY !!

CONCLUSION: Starbucks has written the book on service and hospitality in the QSR space, creating a worldwide brand (now 32,000 stores !) in the process, admirable on many levels. There is no reason we know of that the extraordinary performance will not continue to be the case. From the standpoint of investing in SBUX, the P/E of 28.8x expected earnings in the current year, and over 20x TTM EBITDA, now growing at 8-10% annually,  seems to adequately value the equity in the next year or two. Longer term, if valuations in the general market hold up, SBUX, the stock,  should do fine as it grows materially faster than the worldwide economy as a whole.

THE COMPANY: Starbucks began in 1985 and today is considered the premier roaster, marketer and retailer of specialty coffee in the world. Currently, Starbucks operates in 81 markets around the world. Besides coffee, Starbucks sells a variety of teas and other beverages as well as a variety of high-quality food items. In recent years about 20% of company operated locations has been food. Starbucks also sells their products through other channels such as licensed stores, grocery stores and other food service outlets through their global coffee alliance with Nestle’s S.A.

Starbucks has three  operating segments: (A) the Americas which is inclusive of the U.S., Canada and Latin America, (B) International which is inclusive of China, Japan, Asia Pacific, Europe, Middle East and Africa, and (C) Channel Development. Revenue as a percentage of total net revenues for fiscal 2019 were as follows: Americas 69%, International 23% and Channel Development 8%.

UNIT DEVELOPMENT: 

DEVELOPMENT COMMENTARY: Total global store count increased 1,932 locations or 6.6% over fiscal year 2018. The greatest increase in company stores came from International markets, China in particular with 602 net new stores (629 opened and 27 closed)  bringing the total there to 3,521.  The Americas increased store count between 2018 and 2019 by 2.9% to 9,974. Licensed stores increased by 10.3%, with growth most notable in Korea, which added 103 net units to a total of 1,334, U.K adding 54 to total 707, Turkey adding 41 to 494, Indonesia adding 56 to 421 total, Philippines adding 37 to 397 total, and Thailand transferring 377 from the company to 392 total licensed at year end.

UNIT LEVEL ECONOMICS:

UNIT LEVEL ECONOMICS COMMENTARY: While we can calculate that the AUV, worldwide, for company operated locations is slightly under $1.4M, and the stores are very profitable to be sure, it is difficult to be precise about store level economics. Unit level results vary between markets that are spread worldwide, and licensing income and expenses come into play as the company reports by geographical segment. As a guide however, and using The Americas as the best indication, we provide the table above. Note that Cost of Goods include equipment and product sales to licensees so we calculate all expense lines against total net revenues which include license fees. With that in mind, CGS decreased in fiscal 2019 over fiscal 2018 by 90 basis point. Store Operating Expenses (including Labor and Benefit costs) increased by 110 basis points primarily driven by investments in the Labor content. On this basis, Approximate Store Level EBITDA was virtually flat at 26.6% of Total Net Revenues. It’s good to sell an addictive product 😊

SAME STORE SALES:

SAME STORE SALES COMMENTARY: 2019 global same store sales, as indicated above, increased by 5% in fiscal 2019 driven by 3% increase in average ticket and a 2% increase in comparable traffic. In ’19, SSS was 5% in the Americas (including 2% transaction growth), 3% International (1% transactions).

RECENT DEVELOPMENTS: (Per the year end earnings release and conference call) Noteworthy developments in the year ending 9/30/19, in addition to corporate growth in units and sales cited above, include: Active Starbucks’ Rewards membership in the US  up 15% to 17.6M, returning $12B to shareholders in the form of dividends and share buybacks, benefit from the licensing of their CPG and foodservice to Nestle that was closed in late Aug.’18. Operating income in the Americas was up 5% YTY, 70 bp less than the prior year, with a 9% increase in revenues.This decreased operating margin was due to the Starbucks Leadership Experience, providing higher wages, benefits and labor hours, which was partially offset by cost savings initiatives and sales leverage. Internationally, Operating Income was up 18%, up 180 bp on a 6% increase in revenues. It was driven by 11% store growth, as well as cost savings and the conversion of certain retail business to licensed markets, partially offset by higher wages and an unfavorable product mix shift.

Fiscal 2020 guidance included global comp sales growth of 3-4%, about 2,000 new stores globally (1400 international plus 600 in the Americas), consolidated GAAP revenue growth of 6-8%,  consolidated operating income growth of 8-10% (with obviously higher operating margin), an effective tax rate of 22-24%, GAAP EPS from $2.84-$.2.89 (non-GAAP from $3.00-$3.05), capex of about $1.8B. Interesting (to us, anyway) that Bloomberg, as shown in the template above, carries the non-GAAP estimate. Whatever happened to Generally Accepted Accounting Principles?

On the conference call: Management pointed out that the fourth quarter comp of 6% in the US included transaction growth of 3% and a two year comp of 10%. China, also, had a very strong Q4, with a 5% comp including transaction growth of 2% (which this year reversed previous slightly negative transaction counts) and a two year comp of 6%. Cold beverages are helping, with Nitro Cold Brew introduced in the US last summer and The Pumpkin Cream Cold Brew this past fall. The Reward Program now has over 10 million active members in China (up 45% YTY), on top of the 18M in the US, where the program is generating 42% of store revenues. Also in China, Starbucks is now delivering to over 3,000 stores, mobile orders amounted to 10% of sales with 7 points from Delivery (only 1% of sales in the US) and 3 points from pickup. In China also, perhaps driven by the competitive efforts of Luckin Coffee, a new Voice Ordering and Delivery  by a “Tmall Genie” was introduced to enhance the mobile experience. Management also made the point that the Global Coffee Alliance, with Nestle, was EPS accretive in ’19, faster than originally expected. Overall, CEO, Kevin Johnson, summarized the strength of the Starbucks brand well. “Growth at Scale has really enabled us to ..differentiate Starbucks…the focus that we’ve put on the customer experience…the beverage innovation…..the digital customer relationships..executed with a discipline that has driven our customer connection scores to an all time high.”  We have only touched on a small portion of the various operating initiatives taking place at this premier worldwide brand. Those of our readers that are interested can access the full conference call transcript at www.starbucks.com.

CONCLUSION: Provided at the beginning of this article

 

 

 

 

 

 

 

 

STARBUCKS (SBUX) AND RESTAURANT BRANDS (QSR) GET HIT – A SIGN OF THE TIMES

STARBUCKS (SBUX) AND RESTAURANT BRANDS (QSR) GET HIT – A SIGN OF THE TIMES

Two prominent restaurant companies are in the news today, both SBUX and QSR  are down materially today, and there are lessons to be learned. From a broad brush standpoint, It continually amazes me how the “wealth effect” as a result of worldwide zero interest rates has inflated stock and bond prices to unheard of multiples of cash flow and earnings per share. We have lived through similar periods of new valuation parameters, the “one decision” stocks of the early 1970s that sold (for a while) at 50-100x expected earnings, and the dotcom bubble of 1999-2000 when companies were valued based on eyeballs and multiples of sales and business plans, rather than operating results.

RESTAURANT BRANDS (QSR)

Restaurant Brands’ (QSR) controlling shareholder, 3G Capital Partners, a Brazilian company, has owned most recently 41% (190M shares, worth a cool $14B) of the fully diluted shares of QSR.  QSR has been a great investment for 3G, and Bill Ackman’s Pershing Square Capital (who currently owns owning 15M shares, worth about $1B). While earnings and cash flow  progress have slowed down in recent years, and you can read all about it within our website. The QSR stock has continued to levitate, currently selling very near its all  time high, at almost 30x ’19 EPS estimates and 20x TTM EBITDA. Considering that EPS is growing at about 10% annually and EBITDA growth closer to 5%, this “asset light”, “free cash flow” franchising company that happens to be carrying $11B of debt, not too many observers would call QSR a great bargain. It is therefore no wonder that 3G just announced the sale of 17M shares, worth about $1.3B, and of course the institutional market snapped it up. It’s worth noting that 3G sold $530M worth of shares in calendar ’18 and $330M worth in’17, and QSR bought those shares, rather than reducing their debt. For whatever combination of reasons, QSR stepped aside this time, and let the market absorb those shares. On a smaller scale, Pershing Square Capital Management, has lightened up as well, selling 4M shares in Q2’19 and 8M shares in total in the last twelve months.  We believe that the current valuation is mostly supported by “TINA” (there is no alternative) investing in equity markets when $16 trillion of sovereign debt around the world yields  nothing.

STARBUCKS (SBUX)

Starbucks (SBUX) is a different story. Just a couple of months ago the Company raised guidance for earnings over the next year or so, and combined with firming comp sales and the prospect for growth in China, the stock has hit a new high close to $100 per share, selling at 33x EPS estimates for the year ending 9/30/19 and 22x TTM EBITDA. This is a great worldwide brand, but, here too, the current valuation is far from a bargain relative to the expected growth of about 10% per year.  SBUX was down 4% today because they presented at a Goldman Sachs conference and lowered EPS growth expectations to something short of 10% in the year ending 9/20. We haven’t seen the details of the presentation yet but the headlines indicate that this adjustment of several percent is apparently the result of tax comparisons and a lower stock repurchases in ’20 vs. ’19. The fundamentals do not seem to be deteriorating, so the 3-4% stock decline seems to be a result of “uncertainty” combined with SBUX being “priced for perfection” and leaving room for disappointment. SBUX is a far stronger company, in lots of ways, than QSR, but, here again, the valuation is far from a bargain, and we believe the downside “adjustment” could be much more substantial should a further disappointment develop.

THE DOWNSIDE…

There are a couple of very recent examples of the danger of complacency relative to valuation of growth stocks. Ulta Beauty (ULTA) and Olllie’s Bargain Outlet Holdings  (OLLI) have both been outstanding investments in the retail sector for years, for good reason. In the last five years, with the EPS ramping, ULTA moved from about $100/share to $350, and OLLI went from $20 to about $100. Valuations of both companies moved up to the range of 40-50x expected earnings, “priced for perfection”, just like SBUX and QSR. Just in the last week, both ULTA and OLLI reported strong quarters, met earnings estimates, had  positive comps, but both “adjusted” guidance by a few percentage points, still projecting continued solid growth, just not so quite so solid as previously assumed. The bottom line is that ULTA sold off 25% in one day, now trading at $233, down 36% from a high of bout $365  a month ago, and 0LLI sold off about 30% in one day, now trading at $56, down 44% from over $100 several months ago.  ULTA is now selling at a much more reasonable 20x ’19 EPS, and OLLI is selling at “only” 28x ’19 EPS.  Both these companies are debt free, by the way. In our view, ULTA is a category killer in it’s space, generating a 38% ROE and 18% ROA. OLLI is not quite so impressive, but generates a 15% ROE and 11% ROA, a lot better than the 2.7% ROA generated by QSR, not as good as the 27% ROE generated by highly leveraged QSR which has bought back so much stock. In a nutshell, while ULTA and OLLI are not a close fundamental comparison to SBUX and QSR, we believe the the very recent “adjustment” in valuations illustrate the substantial risk that investors sometimes overlook.

CONCLUSION

Companies that are “priced for perfection”, as are SBUX and QSR at the current time, have serious downside price risk, even if small disappointments have been previously overlooked in a generally strong equity market.  An unexpected new chink in the armor, as demonstrated recently by ULTA and OLLI, can create an “air pocket” in the stock price that wipes out multi-year stock price appreciation. The company specific risk is in addition to that of the general market.  Be careful out there.

‘Roger Lipton

STARBUCKS UPDATED WRITE-UP

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BILL ACKMAN, WITH 41% OF ASSETS IN QSR, CMG AND SBUX COMBINED, IS STILL NOT WELL POSITIONED

BILL ACKMAN, WITH 41% OF ASSETS IN QSR, CMG & SBUX COMBINED, IS STILL NOT WELL POSITIONED

We wrote an article on October 11th, discussing the three major positions in Bill Ackman’s Pershing Square Capital portfolio, within our knowledge base, that comprise a massive 41% of his $8.3 billion portfolio.

At the close of business, October 11th, Restaurant Brands (QSR) was $56.26, Chipotle (CMG) was $434.06, and Starbucks (SBUX) was $54.87. Our conclusion on October 11th was that he should switch his QSR immediately into McDonald’s (then at $163.98), sell his CMG to take advantage of the huge move since new management has been installed, and hold his SBUX (which has moved up nicely).

We have no reason to think that he has made any moves in the last several weeks, but Restaurant Brands, McDonald’s and Chipotle have all reported third quarter results. Starbucks reports tonight.

From the close of business October 11th to last night’s closing price, Restaurant Brands, at 53.06 was down 5.7%, or $85M on the $1.5B position. McDonald’s, at $178.42 was up 8.8%, so would have made Ackman’s Pershing Square Capital a profit of $132M. Chipotle closed at $465 so Ackman would have foregone a profit of 7.1% or $63M on his $900M investment.

Our advice, less than three weeks ago, to Ackman can definitely be considered “theoretical” in terms of the practical ability to switch $1.5B positions instantly, or sell $900M worth of Chipotle on the spur of the moment, and Ackman’s positions are established on the basis of long term prospects. Acknowledging that three weeks doesn’t “make a season” or prove a thesis, Ackman’s portfolio would be ($132M+85M-$63M) a cool $154M better off, or 4.5% of the $3.4B in these three positions, especially costly when all hedge fund managers are fighting for every basis point in a difficult market environment.

Our points here are (1) too many multi-billion hedge funds, and other institutions are playing hunches rather than making well informed long term judgements. This is a function of not enough really attractive reward/risk investment propositions when trillions of dollars of capital are competing to generate “alpha” after nine years of a bull market (2) there is too much emphasis on short term performance, trying to “game” the monthly comps for example,  rather than evaluate long term strategic positioning (3) in too many cases, the self confidence of multi-billion dollar money managers is unjustified. They are very smart, hard working, in many cases have become very rich (which breeds inflated egos), and can’t be expected to know as much they should about every industry. Rather than make Bill Ackman an undeserved particular example: Eddie Lampert, still a billionaire, had no chance whatsoever to turn around Sears based on his strategies, and there were lots of highly experienced retailers that could have told him so. It has taken ten years to play out, but it was clear to many of us years ago that the brilliant and successful Lampert was wasting enormous time and money on Sears.

If we were speaking with Ackman today, we would suggest that it’s not too late to adjust the portfolio. The last three weeks are history.  Let’s see what happens over the longer term.

Roger Lipton

DOMINO’S REPORTS, EARNINGS BEAT, COMPS BARELY LIGHT, STOCK (DPZ) DOWN 5%, OUR TAKE…….

DOMINO’S REPORTS, EARNINGS BEAT, COMPS A LITTLE LIGHT, STOCK (DPZ) DOWN 5%, OUR TAKE…….

We recently (10/5) published our updated writeup on Domino’s, a fully copy of which is provided below. Our conclusion, with the most pertinent bullet points BOLDED, was as follows:

“We have no quarrel with the consensus that Domino’s is writing the book in the pizza delivery business, and there is no apparent reason that they will lose market share to Pizza Hut or Papa John’s. We can’t help but point out, however, that the recent rate of increase in Operating Earnings (rather than the more dramatic recent EPS growth), at roughly a “mid-teen” rate, should probably be the expectation. This still admirable growth rate would be driven by a 6-8% (more likely to be closer to 6 than 8 in the near term) rate of net new stores, a mid-single-digit comp (against very tough comparisons), a bit of SG&A leverage and/or fewer shares outstanding. This year’s tax impact won’t be duplicated. Relative to the share repurchases, if we were on the Board we would not be enthusiastic about (according to Bloomberg) share repurchases at 34x ’18 earnings, 24x trailing EBITDA, 33x trailing Cash Flow and 45.3x trailing Fee Cash Flow. Even when borrowing at still low interest rates, the EPS accretion at this valuation is modest. The regular dividend, yielding 0.7% currently, has been increased each year, but perhaps shareholders would better appreciate another special dividend (last paid in 2012 at $3.00 per share), or a substantial increase in the regular dividend, rather than spending hundreds of millions to buy back stock.

We wouldn’t want to be short this fine company’s stock, and DPZ has been a fantastic holding over the last decade, but we have a feeling that “the easy money has been made”.

With that background, recent developments by way of the third quarter results were as follows:

The Q3 earnings “beat” of $1.95 vs. Street expectations of $1.75 was driven by fewer shares outstanding (43.0M vs. 47.7M) and a low tax rate. The company continued its aggressive repurchase program by spending $109.1M in Q3 at an average of $274/share and an additional $10.0M in just the first 11 days of October at $273/share. The tax rate in Q3 was only 15.3% vs. 33.3% in ’17. Income from operations was up 13.1% in Q3, up 13.3% for the nine months, so the gain has been narrowing.

Same store sales were up 6.3% domestically, barely below the expectation of 6.5%. International comps were up a more modest 3.3%. Net new units were up 232 globally, 173 internationally and 59 in the US. This was just above the 217 net new units in Q3’17, 164 internationally and 53 domestic, so the trailing twelve month continues to be right at the 6% level versus the base, at the low end of the 6-8% range over 3-5 years to which the company has guided. It is a strong commentary on the health of the system that only 21 stores (out of over 15,000) have closed in the last twelve months, 19 internationally and 2 domestically.

It was interesting to us that the comp increases, both domestically and internationally were driven by transaction growth, as well as ticket growth in the US. The Piece of the Pie loyalty program was called out as a meaningful contributor to the traffic gains. It may be an important insight, provided by management in the course of the conference call that “it is transaction count growth over time that correlates not only with sales growth, but with profit growth……our Piece of the Pie rewards program….the foundation was built on driving frequency…points are earned based on the number of purchases as opposed to the amount of dollars spent”. While there are lots of contributing factors to transaction growth, or lack thereof, we can’t help but contrast the consistent growth in comps at DPZ with the now acknowledged traffic slowdown at Starbucks since they changed their loyalty program a couple of years ago to reward dollars spent rather than transactions. Seems worth thinking about.

Otherwise, there were few surprises. Higher labor expenses continue to be a burden, and the commodity basket has been up 3-4% year to date. No guidance relative to future commodity cost was given.  There is continuing capital spending to support supply chain distribution. The Hotspot initiative is promising, with more than 200,000 locations in the US, but no operating details were given. The bulk of the conference call was dedicated to a reiteration of the long term goals, described in our full writeup from 10/5 provided below.

Conclusion: Post Q3’18 Report

Very much the same as provided a couple of weeks ago, and reprinted above. The company is doing well, and there is no reason that they can’t continue their leadership position for the foreseeable future. However, in terms of the DPZ, the stock, there is no particular material positive catalyst on the horizon that would cause a “re-rating” on the upside. We think there could be at least modest risk from this price level, in the short run, from industry -wide concerns, a general market downturn, or a modest slowdown within the operating results at DPZ.

DOMINO’S PIZZA – Updated Write-Up And Conclusion

October 5, 2018

CONCLUSION:

We have no quarrel with the consensus that Domino’s is writing the book in the pizza delivery business, and there is no apparent reason that they will lose market share to Pizza Hut or Papa John’s. We can’t help but point out, however, that the recent rate of increase in Operating Earnings (rather than the more dramatic recent EPS growth), at roughly a “mid-teen” rate, should probably be the expectation. This still admirable growth rate would be driven by a 6-8% (more likely to be closer to 6 than 8 in the near term) rate of net new stores, a mid-single-digit comp (against very tough comparisons), a bit of SG&A leverage and/or fewer shares outstanding. This year’s tax impact won’t be duplicated. Relative to the share repurchases, if we were on the Board we would not be enthusiastic about (according to Bloomberg) share repurchases at 34x ’18 earnings, 24x trailing EBITDA, 33x trailing Cash Flow and 45.3x trailing Fee Cash Flow. Even when borrowing at still low interest rates, the EPS accretion at this valuation is modest. The regular dividend, yielding 0.7% currently, has been increased each year, but perhaps shareholders would better appreciate another special dividend (last paid in 2012 at $3.00 per share), or a substantial increase in the regular dividend, rather than spending hundreds of millions to buy back stock.

We wouldn’t want to be short this fine company’s stock, and DPZ has been a fantastic holding over the last decade, but we have a feeling that “the easy money has been made”.

COMPANY OVERVIEW (2018 10-K; Analyst Day Slides January 2018)

Domino’s, with more than 14,856 locations in over 85 countries around the world, is the largest pizza company in the world based on global retail sales. Founded in 1960, Domino’s roots are in pizza delivery; however, in recent years a significant amount of sales have come from carryout. On average, Domino’s sells more than 2.5 million pizzas each day.

Domino’s business model is simple – they handcraft and serve quality food at a competitive price with easy ordering access and efficient service enhanced by their technological innovations.

Domino’s generates revenue and earnings by charging royalties and fees to their franchisees. The Company also generates revenue by selling food equipment and supplies to franchisees, primarily in the U.S. and Canada, and by operating a number of Company owned stores. In Domino’s international markets, they generally grant master franchises for a geographic area. These master franchises are charged with developing their geographical area and they may profit by sub-franchising and selling food and equipment to these sub-franchisees as well as by running their own stores.

Domino’s business model yields strong returns for their franchise owners and Company owned stores. Historically, Domino’s has returned cash to their shareholders through dividend payments and share repurchases.

Domino’s pioneered the pizza delivery business and has become one of the most widely recognized consumer brands in the world. Since 1998 the Company has been structured with a leveraged balance sheet and has completed a number of recapitalization events. The Company’s most recent recapitalization transaction (in 2017) primarily consisted of the issuance of $1.9 billion of fixed and floating rate notes and the repurchase and retirement of $910.2 million of previously outstanding fixed rate notes. Following this recapitalization, the Company has $3.15 billion in total debt. Excess proceeds were primarily used to repurchase shares of common stock.

LONG-TERM BUSINESS STRATEGY (2018 10-K)

Begun in 2009, Domino’s first priority was to reinvent their core pizza, and they relaunched the brand by introducing a new recipe for their signature product. Next, they improved existing products and/or introduced new items that complimented changes to the core pizza.

Secondly, in 2013 they launched the program to reimage the stores to be more attractive for carryout customers – creating the “Pizza Theater” design which allowed customers to see the process of pizza making. Market studies and current sales trends (from NPD/Crest) had revealed the take-out business was much bigger than delivery. In 2017, delivery business equaled slightly over 1 billion occasions whereas carryout was over 2.5 billion occasions. Since Domino’s carryout focus was launched in QTR-1 2011, Domino’s share of carryout has risen from 7.5% to 14.4%. Carryout necessitates Domino’s to be closer to the customers, therefore, the Pizza Theater helped address this but what was also needed was more locations to make carryout more convenient. In their 2018 Investor Day Presentation, Domino’s management discussed this plan in some detail. It is called Fortressed Markets and is based on realigning the franchise system with programs that encourage strong franchisees that wanted to grow multiple opportunities, both to open new locations and to buy out weaker franchisees in their market areas. Since 2016, Domino’s U.S. franchise base count has moved from 1,300 to 800. This new alignment continues to drive growth with those franchisees who share the Corporate vision. Another component of the Fortressed Market program has franchisees investing heavily by splitting their markets into smaller delivery/carryout areas. According to Domino’s Internal Data (Analyst Day slides) the majority of a location’s carryout business is within 6 minutes of the store. Seattle, WA was one of the first markets to engage in Fortressed Marketing and saw AWGS increase from $20.7K to $26.3K over a 3-quarter period in 2017.

Thirdly, priority was an aggressive investment in technology (which began in 2010) to be the leader in making connections with consumers through technology that exceeded their expectations. This became an aggressive investment in building digital platforms and eventually data analytics in-house. In 2016 Domino’s developed its own digital platform to manage internal operations and customer-facing actions all with the goal to simplify ordering and payment processing and enable order tracking on virtually any communication device. The system is called GOLO (Global Online Ordering). Together with a sophisticated loyalty program (launched in 2016), the platform provides a rich source of data for its robust marketing initiatives.

While Domino’s continues to innovate around the brand’s interactive experience with consumers, nothing has been, or presumably will be, embraced or created that can disrupt operations. Domino’s has preserved the integrity of their brand with an emphasis on continuity relative to their heritage.

SOURCES OF REVENUE (2018 10-K):

As of its 2018 10-K Report, Domino’s operated and franchised 14,856 units globally generating more than $10,638 billion, making them the second largest pizza chain (after Pizza Hut) in sales and the number one pizza delivery company. Approximately one-half of the global sales are generated by 5,587 domestic stores (5,195 franchise and 392 Company). The remainder is produced by 9,269 franchised stores in over 80 markets around the world. Additionally, $1.7 billion is generated from Domino’s supply chain.

Domino’s revenue is generated from multiple sources: domestic franchise fees (5.5% of franchisee sales), international master franchise fees (3.0%), domestic and GOLO digital fees, and supply chain and Company-owned store segment.

UNIT LEVEL ECONOMICS (2018 10-K; 2018 Analyst Day Slides)

From the FDD and the above sources, we estimate AUV’s of Company units are slightly over $1.2M (or about $837/sq. ft. assuming the average store size of 1,500 sq. ft.) and domestic franchised units AUV’s are about $1.0M. Disclosed average store level EBIDTA of domestic franchisees is about $136K – up from $61K in 2009 or a store level margin of 13.6%. (These figures are presumably net of royalty fees and advertising fund contributions.) The cash investment for leasehold improvements, furniture, fixtures, equipment, signage for a new store (provided from Domino’s FDD) is about $410K. Accordingly, the $136K store level EBITDA would represent a store level cash on cash return of 33.1% for a domestic franchised unit.

The supply chain provides pricing and distribution scale and consistent uniform quality ingredients to participants. It operates 18 regional dough manufacturing and food supply chain centers in the U.S. It also operates centers in Canada and leases a fleet of more than 500 tractors & trailers.

SHAREHOLDER RETURN (2018 10-K):

Domino’s 1, 3 and 5-year stock performance has been 24.4%, 147.3% (35.2% CAGR) and 440.9% (40.1% CAGR) respectively. Including reinvestment of dividends, total return for the same periods have been 25.3%, 153.0% (36.2% CAGR) and 457.4% (41.0% CAGR).

RECENT DEVELOPMENTS (PER Q2 EARNINGS REPORT AND CONFERENCE CALL)

Domino’s continued its outstanding performance in Q2, with domestic same store sales up 6.9%, international up 4.0%. It was the 98th consecutive quarter of int’l SSS growth, only the 29th domestically. Diluted EPS was up 34.8% on a GAAP basis and 39.4% “adjusted”. Impressive as the performance is, it should be noted that Income from operations (pretax) was up a more modest (and sustainable) 11.5%, with the higher percentage increases driven by 12.5% fewer shares outstanding and a tax rate of 15.1% versus 25.7% a year earlier. There were 156 net new stores added to the system, 113 internationally and 43 domestically.

The second quarter was highlighted by the innovate launch, late in Q2, of over 200,000 Domino’s Hotspots in the US. Financially speaking, the April recapitalization included $825 million borrowed, of which $490 million paid off previously issued notes. Also in Q2, 905,556 shares were repurchased for $219M and $0.55 per share was paid in dividends.  Remaining share purchase authorization amounted to $429.9M at the end of Q2. The operating numbers above are fairly consistent with the previous quarter, though lower, and the six month increase in operating income was 13.4%.

The Conference Call provided some additional operating details.

US franchisees’ SSS were up 7%, with company stores up 5.1%. The company continues to spend a substantial sum in technology related capital spending, now expected to be $115-120M in ’18, up from a previous estimate of $90-100M.  Supply chain investment is being accelerated, including additional distribution centers in the US, to support the double digit gross sales growth. Carryout business is viewed as a separate occasion from delivery, largely incremental, and advertising is targeted accordingly. Points of distribution, including Hotspots are also being designed with that in mind. The impact of Hotspots was not clear as of the end of Q2, including the incremental effect, but should be more apparent by the end of Q3. Management is guiding to 3-6% long term SSS growth internationally, slowing a bit from the more rapid growth recently.

On a trailing twelve month basis, 905 total net new stores were added, most of them internationally, as has been the case in recent years.  There was a modest slowdown in the rate of international openings in the first half of ‘18, but that is expected to be temporary, a consolidation of sorts after opening over 1,900 net new int’l stores in 2016-2017. The estimate continues to be 6-8% annual net new units on a global basis. The 905 net new stores opened (almost exactly 6% of the 15,122 base), of which 651 were international, including only 113 in Q2, so the Q2 pace is clearly below that.

CONCLUSION: Provided at the beginning of this article.

 

 

 

 

 

STARBUCKS (SBUX) – IT’S NOT JUST ABOUT HOWARD SCHULTZ LEAVING

STARBUCKS (SBUX) – IT’S NOT JUST ABOUT HOWARD SCHULTZ LEAVING

Starbucks, and Howard Schultz, are all over the news recently, most notably after the incident in Baltimore that resulted in closure of 8,000 stores for an afternoon, and the founder stepping down after an extraordinary career building one of the most prominent worldwide consumer brands, in our mind “writing the book” in hospitality among QSR operators. Our concerns, and expectations for Starbucks’ future are more long term in nature, than the result of the bias training, or management transition.

We reprint below several of our most recent articles, the most relevant of which was done in March of this year.  As of the moment, I would only add to the discussion below that Howard Schultz’s political leaning will not maximize the appeal of the Starbucks brand, which has already shown less momentum than in the past. I’ve spoken to golfers who won’t play a Trump golf course or stay at a Trump hotel, and consumers who won’t go to Norstrom’s after they took Ivanka  Trump products out of the store. While Howard Schultz makes an articulate argument that a company cannot ignore social issues, there are no doubt a number of coffee drinkers who just want a cup of coffee and a smile and will go elsewhere.

March 12, 2018

We have written a number of  articles over the last two year, with excerpts provided below. We have consistently expressed our admiration for this worldwide brand, at the same time pointing out that the “easy money” has been made. We think it is no accident that the stock has done nothing since late 2015,in a trading range from the low 50s to the low 60s while adjusted EPS increased from $1.58 in the year ending 9/30/2015 to $1.91 in fiscal 2016 and $2.06 in ’17. It is timely to re-examine our thesis, as the stock trades toward the high end of its two year trading range, during which it has underperformed the market, we believe with good reason.

On August 2, 2017, I wrote an article describing the changing business model at Starbucks, including the possibility of unintended consequences.

THE TIMES THEY ARE A’CHANGIN’

BARRON’S MAGAZINE this morning has a front cover entitled THE FUTURE OF COFFEE (AND RETAIL). The subtitle reads “Starbucks has succeeded where Silicon Valley hasn’t: changing the way consumers pay. The behavioral shift holds big promise for the coffee giant and its stock”.

Not exactly, in my opinion. It is not just about “the law of large numbers”, and the difficulty of satisfying investors by building on profit margins that are well above peers. The business model has changed, and the question becomes whether the new model will match the original. It’s well known that a new loyalty program bothered some customers and also that an increasing number of customers are ordering and paying online, often in advance of entering the store. In the most recent quarter, 30% of US transactions were paid using the smartphone app, up from 25% a year earlier and 20% two years ago. More important, to my view, is that 9% of US orders were ordered and paid for in advance. The company has been discussing the store level congestion for several quarters now, as mobile orders slow down service for customers going through the line. Perhaps it’s just me, but I am put off somewhat when the line at the register (where I like the human contact) is short, but I have to wait while eight or ten orders are pumped out ahead of my own.

MILLENNIALS, WHO ARE THE SPENDERS, DON’T VALUE HUMAN CONTACT (AS MUCH)

It’s not so long ago that pundits dismissed the internet as a retail venue. The public was not expected to give out their credit card information, and certainly was not going to buy “touchy, feely” products like apparel or shoes through online channels. The public is not only ordering “everything” through Amazon and others, but relationships are maintained through Facebook and other social channels. As a corollary, customers are increasingly seeking “experiential” retail situations, rather than visit the malls, with their undifferentiated stores and restaurants, most often staffed with poorly trained employees.

WHAT’S IT ALL MEAN TO EMPLOYEES, AND CUSTOMERS?

Relative to Starbucks, their leadership with mobile order and pay, increasingly in advance of the store visit, may well be appropriate and necessary, but the business model has changed. It’s become a production challenge, not a relationship driven enterprise. The employed “people person” who was the star of the previous model, is not going to be as easily satisfied, because most of the employees, for most of their time, are busy pumping out product. It’s going to be harder to find someone such as the barista at “my” Starbucks who told me that Starbucks “is making me a better person”. From the customer side, there are 27,000 stores already existing that are already tightly configured and can’t be reconfigured too much to handle a lot more production. From a customer standpoint, some, like myself (perhaps in the minority these days), who value the human contact, may decide that the local independent shop, or even the home or office kitchen, can provide an adequate cup of coffee at a competitive price without the “tumult”.

CONCLUSION

I remember when Howard Schultz said that food will never be a material part of Starbucks’ sales. Today, it represents 30% of revenues. Schultz originally envisioned his coffee shops as a “third place”, to hang out other than home or office. That’s a little hard today, in a small busy shop, but we can call this an “unintended consequence” of building one of the still growing premier worldwide brands. Comps and traffic have slowed in recent years, due to the “law of large numbers”, the natural limitations of small stores that were not originally built to handle today’s volumes, and the evolving environment that every successful retailer must adjust to. Starbucks is one of the most successful retailers ever created, and we don’t doubt that they will continue to succeed in a major way. We caution however, that the rate of progress demonstrated in the past, already slowing, will be increasingly difficult to replicate. The business model has evolved. Starbucks was a retail “disrupter” but their previous approach may not be quite as successful. Accordingly, valuation parameters that have applied to SBUX equity in the past may not apply in the future. The stock chart that has languished over the last couple of years may well be reflecting the most likely future business model; still good, just not quite as great.

STARBUCKS – Great company, still, but stock will continue to underperform

STARBUCKS (SBUX) – Great company still, but operating earnings are flat, and stock is expensive. Always has been expensive, but growth in earnings and cash flow is not what it was.

Introduction:

We have written a number of  articles over the last two year, with excerpts provided below. We have consistently expressed our admiration for this worldwide brand, at the same time pointing out that the “easy money” has been made. We think it is no accident that the stock has done nothing since late 2015,in a trading range from the low 50s to the low 60s. While adjusted EPS increased from $1.58 in the year ending 9/30/2015 to $1.91 in fiscal 2016 and $2.06 in ’17. It is timely to re-examine our thesis, as the stock trades toward the high end of its two year trading range, during which it has underperformed the market, we believe with good reason.

Most Recent Results Support Conclusion

The following is a very brief summary. See our full writeup,

https://www.liptonfinancialservices.com/2018/01/starbucks-2/

for more detail.

Fiscal Year ending 9/30/17 included consolidated net revenues up 7% (adjusted for the extra week in ’16), global comp sales up 3%, GAAP operating income down 0.9%, non-GAAP operating income up 7.8%. GAAP EPS grew 3.7% while non-GAAP EPS (which the Company and analyts prefer to use) grew 11.4% to $2.06 per share. Without reviewing all the multi-year trends, the growth in revenues has slowed 17% in fiscal 2015 to 11% in 2016, and of course much higher rates of growth prior to 2015. It is worth noting that China/Asia Pacific has built revenues at a 42% rate over the last three years (vs 9% in the Americas) and will continue to grow rapidly, but represents only about 14-15% of total revenues. With ’17 completed, management provided long term financial targets which included annual comp growth of 3-5%, annual net revenue growth in high single digits, annual EPS growth of 12% or greater.

After the first quarter, ending 12/31/17, was reported, showing consolidated revenue growth of 6%, consolidated same store sales growth of 2% (flat traffic),  GAAP operating Income down 1%, and GAAP Operating Margin down 140 bp to 18.4%, the Company updated their fiscal ’18 guidance. They continue to expect 3-5% global comp growth, near the low end of the range and, and (with Q1 at 2%), obviously back loaded. Consolidated revenue growth will be in the high single digits (they say “consistent with long term guidance”). The HSD works out to 7-9% because they say that the 9-11% total expectation includes 2% from the acquisition of East China and other streamlining activities. Non-GAAP EPS is expected to be $2.48 to $2.53, vs. $2.06, which includes the effect of lower taxes (we estimate $0.25-$0.30) and stock buybacks. Subtracting $0.29 of tax effect from $$2.51 (the midpoints) leaves $2.22 vs $2.06 (up 7.7%), a large portion of which would be due to fewer shares outstanding. Suffice to say, therefore, that pretax earnings, and EBITDA, growth, will be modest, at best, and the most recent guidance, in total, implies short term growth at the low end of long term targets.

Previously:

We have written a number of articles describing Starbucks over the last two years, describing the high valuation of the stock and the changing fundamentals, not all of which are necessarily positive.

Late in calendar ’15, we wrote “At 33x estimated forward earnings…… I view SBUX as priced close to perfection. As great as the year (’15)  was, as great as a 9% same store sales comp in Q4 was, a slight slowing, which the company is indicating for the first quarter, and inevitable at some point anyway undermines new buying enthusiasm. Guidance has not been boosted, which is normally necessary for an upside run from this kind of valuation. Having said all that, strange things can happen in this market. My fundamental view is that the stock is “efficiently valued”, not a bargain…

On November 1, 2016, we wrote: “My observation, as a Starbucks customer and corporate fan, is that business is, if anything, slower than in the past. Nothing I hear or see indicates that the quarter ending 9/30 (’15) will encompass a positive Q3 surprise, or increased guidance going forward. The unforgiving environment can affect even a “best of breed” (by far) operator such as Starbucks. Almost any chart analyst would view the situation negatively, foreseeing a price breakdown. Combined with my fundamental view, I see no reason to be a hero here.”

On August 2, 2017, I wrote an article describing the changing business model at Starbucks, including the possibility of unintended consequences.

THE TIMES THEY ARE A’CHANGIN’

BARRON’S MAGAZINE this morning has a front cover entitled THE FUTURE OF COFFEE (AND RETAIL). The subtitle reads “Starbucks has succeeded where Silicon Valley hasn’t: changing the way consumers pay. The behavioral shift holds big promise for the coffee giant and its stock”.

Not exactly, in my opinion. It is not just about “the law of large numbers”, and the difficulty of satisfying investors by building on profit margins that are well above peers. The business model has changed, and the question becomes whether the new model will match the original. It’s well known that a new loyalty program bothered some customers and also that an increasing number of customers are ordering and paying online, often in advance of entering the store. In the most recent quarter, 30% of US transactions were paid using the smartphone app, up from 25% a year earlier and 20% two years ago. More important, to my view, is that 9% of US orders were ordered and paid for in advance. The company has been discussing the store level congestion for several quarters now, as mobile orders slow down service for customers going through the line. Perhaps it’s just me, but I am put off somewhat when the line at the register (where I like the human contact) is short, but I have to wait while eight or ten orders are pumped out ahead of my own.

MILLENIALS, WHO ARE THE SPENDERS, DON’T VALUE HUMAN CONTACT (AS MUCH)

It’s not so long ago that pundits dismissed the internet as a retail venue. The public was not expected to give out their credit card information, and certainly was not going to buy “touchy, feely” products like apparel or shoes through online channels. The public is not only ordering “everything” through Amazon and others, but relationships are maintained through Facebook and other social channels. As a corollary, customers are increasingly seeking “experiential” retail situations, rather than visit the malls, with their undifferentiated stores and restaurants, most often staffed with poorly trained employees.

WHAT’S IT ALL MEAN TO EMPLOYEES, AND CUSTOMERS?

Relative to Starbucks, their leadership with mobile order and pay, increasingly in advance of the store visit, may well be appropriate and necessary, but the business model has changed. It’s become a production challenge, not a relationship driven enterprise. The employed “people person” who was the star of the previous model, is not going to be as easily satisfied, because most of the employees, for most of their time, are busy pumping out product. It’s going to be harder to find someone as described above who says that Starbucks “is making me a better person”. From the customer side, there are 27,000 stores already existing that are already tightly configured and can’t be reconfigured too much to handle a lot more production. From a customer standpoint, some, like myself (perhaps in the minority these days), who value the human contact, may decide that the local independent shop, or even the home or office kitchen, can provide an adequate cup of coffee at a competitive price without the “tumult”.

CONCLUSION

I remember when Howard Schultz said that food will never be a material part of Starbucks’ sales. Today, it represents 30% of revenues. Schultz originally envisioned his coffee shops as a “third place”, to hang out other than home or office. That’s a little hard today, in a small busy shop, but we can call this an “unintended consequence” of building one of the still growing premier worldwide brands. Comps and traffic have slowed in recent years, due to the “law of large numbers”, the natural limitations of small stores that were not originally built to handle today’s volumes, and the evolving environment that every successful retailer must adjust to. Starbucks is one of the most successful retailers ever created, and we don’t doubt that they will continue to succeed in a major way. We caution however, that the rate of progress demonstrated in the past, already slowing, will be increasingly difficult to replicate. The business model has evolved. Starbucks was a retail “disrupter” but their previous approach may not be quite as successful. Accordingly, valuation parameters that have applied to SBUX equity in the past may not apply in the future. The stock chart that has languished over the last couple of years may well be reflecting the most likely future business model; still good, just not quite as great.

Lastly, on January 4, 2018, we wrote:

This is a very big ship, forced to navigate a continuing turbulent, competitive consumer spending environment. Growth in sales and earnings has slowed, and we doubt that EPS growth can be re-ignited, in large part due to the law of large numbers. To some extent, SBUX has become a “cash cow”, very profitable, generating still very high returns on capital, even if the base is growing more slowly. The shareholder base is transitioning to include long term value, and dividend, oriented, investors. In fact, SBUX has been in a trading range from the mid-50s to the low 60s over the last two years, with the stock’s valuation mirroring the slowdown in earnings (and EPS) growth. The corporate initiatives described below, further described by management on their conference call, are all necessary for further progress. Collectively, they can maintain corporate progress, and even move the growth rate by a few points, but we suspect that the days of high single digit comps (in the US) and 20% or better EPS gains are in the rear view mirror. There are now a large number of operational moving parts, not all of which will proceed smoothly. Furthermore, the business model is evolving, with possible unintended consequences, as discussed in our report of 8/22/17. Earnings reports in 2018, as predicted by management, will be muddied by one time transactions, so “adjusted earnings” will be a feature of their reports. Analysts and investors may not care much, if the current forgiving stock market environment continues, but tolerance for lots of adjustments will not be as high if the general market runs out of steam. A revised food menu is in the works but, even if food sales increase, non-coffee margins are lower, so earnings may not “leverage”. Starbucks is a great company, and will remain so, admirable in many ways, a great brand building example. The Company is one thing, the stock another. Investors can, and will, decide for themselves, what valuation is appropriate.

Roger Lipton