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SBUX: NERVOUS NELLY

We’re nervous about this quarter and the remainder of FY12.  The Street’s FY12 expectations imply a strong second half of the year.  We believe that reality is likely to be at odds with those expectations as same-store sales are slowing and the company is ramping up expenditure through investment in several new initiatives. 

Here are the key topics we will be focusing on heading into earnings on 7/26:

  • Guidance: Management is expected to provide its initial outlook for FY13 financial targets
  • Evolution Fresh: The Company previously stated that it intended to have Evolution Fresh beverages available across the Starbucks U.S. retail store system this summer.  We have seen several stores in the NY/NY/CT region without the beverage line and it is almost August!
  • Refreshers:  The new “refreshers” beverage offering has been on offer now for a couple of weeks. 
  • G&A: The Global Leadership Conference that the company is hosting in October is expected to cost $35-40mm.
  • La Boulange: Additional details on the acquisition are expected and we the company to quantify the dilutive impact of the acquisition to FY13 EPS.
  • Accelerating unit growth: The Company’s business is becoming more complex with five concepts in four different segments of the food and beverage industry. 
  • China: Given the recent macroeconomic commentary from list of consumer companies, Starbucks will likely address its performance in China during the second quarter.
  • Europe: MCD had nothing good to say about Europe.

 BULLISH SELL-SIDE

While 80% of the 31 analysts covering Starbucks rate the stock “Buy”, we are of the opinion that management is too optimistic. 

 SBUX: NERVOUS NELLY - sbux sell side sentiment

 Below, we discuss some of the forward-looking commentary recently offered by management:

HEADWINDS

“Now importantly with these headwinds I've spoken about with the fact that in this back half of the year commodity costs are still higher than they were relatively speaking a year ago, with the EMEA headwinds that I've have just spoken about, with the investments that we're making in things like La Boulange, food program overall, the continued integration of the Evolution Fresh business, which we acquired earlier this year, with all those headwinds we're accelerating earnings growth in Q3 and further in Q4.”

HEDGEYE – The Company has said that it expects company-operated comparable restaurant sales to grow at “mid-single digit pace”.  We believe that a 4-5% number would likely fall short of providing the leverage the company needs.  According to Consensus Metrix, the street is looking for 8%, -1%, and 18% growth for the Americas, EMEA, and CAP, respectively. We believe that, on all three counts, the Street is too aggressive.

EARNINGS OUTLOOK

“Now specifically to fiscal 2012, we are expecting earnings per share in the current year of $1.80 to $1.82, that represents about 18% to 20% earnings growth over the $1.52 that we earned a year ago and you can see the big hit that commodity cost take out of this first year right out of the gate, north of $200 million of commodity cost pressure in this fiscal year. Now, specific further to the second half of 2012, growth in earnings is expected to accelerate as we move into this third quarter. Accelerating from the first half of the year to 22% to 25% we expect in Q3 and 24% to 27% earnings growth expected in the fourth quarter. That reflects EPS of $0.44 likely we believe now in the third quarter with upside of that at $0.45. I'll come back to that in just a moment and in the fourth quarter our expected range is $0.46 to $0.47 EPS.”

HEDGEYE – We believe that there is a strong possibility of another guide down when the company reports on Thursday.

G&A OUTLOOK

“Our total business unit G&A as a percentage of total net revenue increased slightly over last Q2 due largely to growth in our Channel Development segment as we ramp up support of the high growth business.” 

HEDGEYE – We know they are building five different concepts and investing in the core food offering.  If the economic malaise persists or worsens, we would expect the company’s margins to deteriorate as a result.

EMEA

“It's clear that we'll have increased pressure from EMEA in this third quarter… we are living in a tough EMEA environment here for a while.”

"In March, our EMEA team launched what we're calling the Renaissance plan, our blueprint for turning around performance in that important region, which is modeled after the success of our transformation agenda in the U.S."

HEDGEYE – We remain skeptical on a turnaround in Europe absent a stabilization of the economic environment there.   The 2Q12 McDonald’s earnings call does not inspire much confidence that a rebound is forthcoming. 

CAP - China/Asia-Pacific

“Operating income in CAP was also strong, increasing 59% to $70 million in the second quarter. Operating margin grew 660 basis points to 39.8% despite higher commodity costs of approximately 140 basis points. This quarter's results were also impacted by the favorable timing of income for certain of our joint venture operations which we do not expect to occur in future. Our team is continuing to do an excellent job of following our growing revenue through to the bottom line, despite continued inflationary pressure in key Asian markets like China.”

HEDGEYE – The one-time items that benefitted results in 2QFY12 are less likely to repeat going forward.  Continuing economic sluggishness, as highlighted by McDonald’s, is likely to impede Starbucks’ progress in the region.

Conclusion

We believe that, over the near-term TRADE and intermediate-term TREND, the Street is too bullish on Starbucks.  There are pockets of hype that continue to buoy sentiment; K-Cups for example, will continue to generate attention but as a relatively insignificant portion of the company’s earnings, that business is unlikely to offset the other major headwinds the company faces heading into FY13.  One tailwind that the company expects in FY13 is coffee costs.  The operating income tailwind should be in the order of more than $100mm and an additional year of favorable coffee costs is expected in 2014.

 

Howard Penney

Managing Director

Rory Green

Analyst