Starbucks posted another strong quarter and the stock is up in aftermarket trading.  We have been long Starbucks since March 2009 and continue to like the long term prospects of the company.


We expected a strong quarter from Starbucks but not a massive beat and the quarter was largely in line with what we expected.  EPS came in at $0.36 versus expectations of $0.34.  Domestic comps were +8% versus consensus +5.3%.  International comps were +5% versus consensus +5.1%. 


Below are the same-store sales charts for domestic and international stores as well as our top ten takeaways from the earnings call.







Top Ten Takeaways:

  1. Earnings growth guidance is, we believe, secure for the company in 2011 and we also feel comfortable with the FY2012 EPS growth guidance of 15-20% given the coming rollout of K-Cups in CPG channels, other sales boosting initiatives, and the company's “LEAN” principles.
  2. Same-store sales in the U.S. completely blew away expectations, coming in far above consensus expectations at 8% (against a 9% comp in the year-ago quarter).  We believe that Starbucks continues to gain traction with consumers.
  3. The strong top-line performance should continue; the company is at the cutting edge when it comes to technology and social media.  Along with Domino’s, another company taking share, Starbucks utilizes technology to improve the guest experience.  The Starbucks iPhone app is one example, allowing customers to pay via their mobile devices and, as part of a recent introduction, send e-gift cards to friends for Starbucks purchases.  Between Android and iPhone apps, the company stated that there are now 1 million devices with more than $50 million loaded for use specifically at Starbucks.
  4. The brand loyalty that Starbucks inspires is almost peerless.  The Starbucks Card and loyalty program had a record quarter in Q3 activating nearly 150,000 cards per day during the quarter and generating a 38% increase in dollars loaded on to cards over the period.  Additionally, Starbucks is the most popular brand on Facebook.
  5. Growth potential for Starbucks remains.  The CPG business, with the rollout of K-Cups is one avenue but store growth also remains a valuable revenue driver.  Next year’s initial revenue growth guidance is 10% driven by CPG, mid-single digit comps, and 800 net new stores.   200 are expected to be domestic and 600 in international markets (150 in China).  Key targets for further, longer-term unit growth include Brazil, which has less than 100 stores, and can one day have at least 1,000 stores according to management.
  6. China is a key focus for Starbucks and the company is following a very meticulous approach to its strategy there.  For instance, recently, the company formed a JV with a farming group in Yunnan, China to produce and process coffee.  As global demand rises, Starbucks is positioning itself shrewdly.
  7. Commodity cost inflation will remain a problem for the company over the remainder of the year.  Full year EPS impact from commodity inflation is expected to be $0.22 with $0.08 coming in 4Q after 3Q’s $0.07 impact. 
  8. K-Cups are expected to add $0.03-0.05 in EPS in 2012.  This is included in the company’s guidance for EPS growth of 15-20% year-over-year for the year.
  9. The company has north of a billion dollars in cash and is looking to increase its activity in the M&A markets going forward.  In 1999, Starbucks acquired Tazo Tea which is now generating more than $1 billion in system-wide sales.  According the management, tea is a $90 billion global market and the second-most consumed beverage in the world after water.
  10. Our final takeaway is that it is ludicrous to pay a higher multiple for the Dunkin’ Donuts “growth” story than the growth that Starbucks promises.  Starbucks has delivered for years as a public company and is a global brand with quantifiable and undeniable appeal for consumers, globally.  Dunkin’ Donuts is a great but regional domestic brand with no track record as a public company.  Sure, the company plans to grow into new domestic markets but growth is expensive as BWLD discussed on its earnings call.  Furthermore, if the brand doesn’t resonate as much as expected in new markets, and the ROI doesn’t meet what the current multiple implies it should be, it could pop the Dunkin’ bubble.


Howard Penney

Managing Director


Rory Green



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Will Obama Do The Two-Step?

“Say, my love, I came to you with best intentions, 

You laid down and gave to me just what I'm seeking.”

- Dave Matthews, “Two Step”


Conclusion: The Boehner and Reid plans are very different structurally.  We expect the Boehner plan to pass this afternoon, which will provide strategic advantage for the Republicans heading into August 2nd.


As Keith noted in the Early Look, the top three stories on Bloomberg this morning related to the debt ceiling.  Admittedly, this story is being over-analyzed and over-studied, but we did want to spend a few minutes highlighting the two most recent plans from Senator Reid and Speaker Boehner and the details therein.


As we highlighted in a note earlier this week, the primary outstanding issue relates to timing.  The Republicans, led by Boehner, are recommending a two-step process.  The first step of the process would involve extending the debt ceiling by $900BN or so, which would be matched by comparable discretionary spending cuts over ten years (duration mismatch, anyone?). The next tranche of a debt ceiling increase of $1.6 trillion would be tied to Congress passing an additional deficit reduction bill that attempts to remove an incremental $1.8 trillion in expenditures related to cuts in mandatory spending programs.  These mandatory spending cuts are to be determined by a 12-member joint leadership committee.


The plan from Reid has a number of noteworthy differences from the Boehner plan. First, the Reid plan is not two-step in nature.  Second, while the Reid plan proposes $2.2 trillion in deficit cuts, the bulk of the cuts in this plan actually come from an assumed winding down of the Iraq and Afghanistan military adventures.  In fact, of the total proposed cuts by the Reid plan, more than $1 trillion come from a wind down of Iraq and Afghanistan.


In the table below, we compare the revised Boehner plan versus the Reid plan as scored by the CBO and based on our interpretation:


Will Obama Do The Two-Step? - 1


While the primary issue between the Democrats and Republicans remains one of timing, the underlying issue, as outlined in the table above, is the exact source of cuts.  The Republicans don’t count the natural winding down of wars as a cut in spending, a stance which is consistent with CBO scoring standards.  On the other hand, Democrats are using the wind down of military spending as the primary component of the deficit reduction plan.  This debate over source of spending cuts is the primary reason that Republicans are pushing for a two-step process.   If the Republicans agreed to the Democratic plan, they would in fact be ceding away much of their long term budget cuts proposals. 


This is not a political statement per se, but we think Speaker Boehner characterized the current political impasse best with the following quote from yesterday:


“There are only three possible outcomes in this battle: President Obama gets his blank check; America defaults; or we call the president’s bluff by coming together and passing a bill that cuts spending and can pass in the United States Senate. There is no other option.”


The vote on the Boehner plan is scheduled for 5:45pm today, after the markets close. The House Republicans, led by the Tea Party Caucus, are adamantly opposed to giving the President any sort of blank check, and so will certainly call the White House hand on the veto threat and pass this bill.   In fact, there is risk that Boehner can’t get the votes he needs this afternoon, though the most recent information we’ve received suggests that he will.


If the Boehner plan does indeed pass this afternoon, the bill then goes onto the Democratic controlled Senate and then, if passed, onto the President to sign, or veto.  From a strategic perspective, the Republicans have positioned themselves well as the proverbial budget ball will be in the hands of the Democrats in the five days leading up to August 2nd. 


The political theater is about to get very interesting in Washington and, despite his veto threat, President Obama may be out on the dance floor doing the two-step in the next couple of days.


Daryl G. Jones

Director of Research


Improving Strip trends and MGM’s earnings release could make BYD the derivative play



Keith added BYD to the Hedgeye virtual portfolio as a LONG this morning at $8.93.  While there were some encouraging signs from its latest quarterly report (i.e. margin improvement, strong regional results, and stabilization of the LV Locals market), the stock has traded off. 


We believe there are a couple of catalysts ahead for BYD.  First up is MGM’s earnings call on August 8th, where we think management will praise the robust LV Strip results in Q2.  BYD could be bid higher as investors look for other ways to play gaming – the thesis being that LV locals improvement should follow the Strip.  July-to-date, BYD’s stock is down -2% while MGM is up 14%.  The second catalyst should be a Q3 beat.  BYD’s decision to resume issuing guidance, its first since it guided for Q3 2008, is a good sign.  We think its 3Q 2011 guidance is conservative and results may come in at the high end of the range.



European Equity Watch: EUR-USD, DAX, FTSE

Positions in Europe: Short EUR-USD (FXE); Italy (EWI); UK (EWU)

As Keith noted in today’s Early Look, alarm bells sounded yesterday on a confluence of factors: 

  1. EUROPE – both European stocks and bonds are turning into a proactively predictable train wrecks. Our research catalysts remain crystal clear (accelerating debt maturities for the majors through September) but, more importantly, now all of our TRADE and TREND lines across every major European stock and bond market (ex-Russia) have been broken and confirmed by volume and volatility studies.
  2. USA – stocks broke their intermediate-term TREND line of support (1320 in the SP500) and short-term bond yields finally busted a move above my 2-year yield TRADE line of resistance (0.41%).  Credit risk derived by market morons in Congress will be priced on the short-end of the curve (where Bernanke has tried to mark it to model for 2 years), so watch that 0.41% line like a hawk.
  3. GLOBALLY – China’s Shanghai COMP TREND line = 2831 (broken); India’s BSE Sensex TREND line = 18,578 (broken); German DAX TREND line = 7251 (broken); FTSE TREND line = 5985 (broken); SP500 TREND line = 1320 (broken); Russell2000 TREND line = 827 (broken); WTIC Oil TREND line = 103 (broken); EURUSD TREND line = $1.43 (whipping around the line)

European indices have been down for the last four days and hit lower today on declining Eurozone confidence readings and a slew of bellwethers missing earnings. We continue to think that European sovereign debt contagion will erode confidence and slow growth across the region, with no country insulated. To this point, Germany’s high frequency data has slowed in recent months with inflation bumping up marginally.


Eurozone Business Climate Indicator     0.45 JUL vs 0.95 JUN (down for 4 straight mths)

Eurozone Consumer Confidence            -11.2 JUL vs -9.7 JUN

Eurozone Economic Confidence             103.2 JUL (vs expected 104.0) vs 105.4 JUN  (down 5 straight mths)

Eurozone Industrial Confidence              1.1 JUL (vs expected 1.6) vs 3.5 JUN  (down 4 straight mths)

Eurozone Services Confidence                7.9 JUL (vs expected 9.2) vs 10.1 JUN


European risk, as indicated by sovereign bond yields and cds prices, has ticked up in recent days following a massive plunge after the announcement of Greece’s second bailout package on 7/21. Critically, the 10YR Spanish government bond yield is above 6%, as Italy’s flirts just below it, and CDS spreads are above the 300bp line for Spain and Italy, two critical (historic) break-out levels (see charts below). Confirming the trend of higher yields, Italy sold €2.7 billion of 10-year government bonds today at an average yield of 5.77% vs 4.94% on June 28.


European Equity Watch: EUR-USD, DAX, FTSE - 1. a


European Equity Watch: EUR-USD, DAX, FTSE - 1. b


Below we show our price level charts for the EUR-USD, DAX, and FTSE. The EUR-USD has held in a band between $1.40 – $1.45 since mid March, and we think has largely been supported by implicit guarantees from European officials to fund fiscally imbalanced countries with favorable short-term bailout packages, and in some cases refuse that possibility of default/exit of any Eurozone member country (Trichet and ECB). 


European Equity Watch: EUR-USD, DAX, FTSE - 1. c


We think Spain (IBEX) and Italy (MIB) have more room to run on the downside, despite being down -13.5% and -20.4% since intermediate term highs on 2/17, respectively. We’re currently short Italy via the etf EWI in the Hedgeye Virtual Portfolio.  We covered our position in Spain (EWP) on 7/26.  Germany has now broken its TREND line of support, an additional ominous sign in our models, as is the UK (FTSE) on sticky stagflation. 


European Equity Watch: EUR-USD, DAX, FTSE - 1. d


European Equity Watch: EUR-USD, DAX, FTSE - 1.e


Matthew Hedrick

Early Look

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