SBUX – PROVING RESILIENT AFTER ALL

The anti-SBUX commentary will fall into two buckets (1) in 2Q09 same-store sales trends declined 8% and on 2-years basis sales trends continues to decline and (2) McDonald's move into the premium coffee segment is going to hurt SBUX when they go on national TV. Importantly, Starbucks proved this quarter that there are significant costs the company can cut to help stabilize margins. It will be hard for any anti-SBUX commentary to say "even with the cost cutting the company can't make the numbers."

 

MARGINS ARE IMPROVING

I don't care how negative people are the Starbuck's, the core of the business model is very healthy and is showing very sustainable trends that that was not there three to six months ago. For the past two quarters the company has posted sequential improvements in operating margins, and will report year-over-year improvement in 3Q and 4Q of 2009. This is directly attributable to the progress SBUX has made on its cost cutting initiatives. In 2Q09, SBUX delivered $120 million in cost savings, exceeding the $100 million target. For the balance of the fiscal 2009, SBUX has cost savings of approximately $150 million in 3Q09 and $175 million in 4Q09.

 

On a consolidated basis (excluding restructuring charges), 2Q09 operating margin was 8.3% versus 8.4% last year. Operating margin in Q2 improved sequentially by 20 basis points from 1Q09. In the U.S. operating margin for 2Q09 was 10.9% versus 11.5% last year (excluding restructuring charges) and internationally 2Q09 operating margins were 4.8% versus 5.1% last year.

 

A very powerful trend in margins!

SBUX – PROVING RESILIENT AFTER ALL - sbux1

 

TRANSACTIONS REMAIN ELUSIVE

The Starbucks critics will be loud and clear that the top line trends are weak and getting weaker. Admittedly, the top line trends remain an issue for the company, but I contend that it's not terminal and many people overstate the impact McDonald's will have on the business. Don't get me wrong; the issues Starbucks faces are far from trivial and McDonald's is a great competitor, but to think that Starbucks is not fixable is crazy. There are a lot of high-end retailers that are not doing well today, but the Starbucks basic drip coffee is anything but expensive at around $1.65 for a 12oz cup.

 

In order to sustain continued stock price appreciation, SBUX cannot rely on cost saving initiatives alone, but the company has bought themselves some time. Investors will expect to see a turnaround in sales to solidify the turnaround. While comparisons do get significantly easier as we move into 2H09, the company finally announced last night that it will launch a multi-million dollar advertising campaign focused on the quality, value and the values that Starbucks offers. The timing of the Starbucks advertising campaign will pre-empt the national launch of McDonald's premium coffee. Given the cost of media today, it's a great time for Starbucks to be launching a national advertising campaign.

 

Also, beginning May 5th Starbucks will offer a Grande iced coffee for less than $2. This is an important step to extend value to the Starbucks customers in an attempt to build transactions. Lastly, the company will fine tune its menu prices in several key markets to better align geographic COGS and labor issues. This will result in minor changes to prices, that that will lower prices on some of our more popular items such as tall lattes and slightly increase prices on larger and more labor intensive beverages.

 

The rate of decline in Starbucks same-store sales is slowing!

SBUX – PROVING RESILIENT AFTER ALL - sbux2

 

GENERATING CASH

In 2Q09 SBUX reduced our short-term borrowings from $290 million to $226 million and does not need to seek an amendment to their credit facility. The potential amendment was driven by the lease termination costs associated with the decision to close another 300 underperforming stores. Starbucks said last night that the impact from lease exit costs for the balance of fiscal 2009 will be lower than previously expected, thus they are no longer pursuing the necessary amendment.

 

Capital expenditures for the first six months were $237, down from the $505 million in capital spending last years. In 1H09 SBUX generated $715 million in cash from operations and $479 million in free cash flow.

 

SBUX – PROVING RESILIENT AFTER ALL - sbux3



VALUATION


With the stock up nearly 45% this year valuation has improved, but the sentiment on the stock has not. As top line momentum begins to improve the flow-thru to EPS will be even greater, given the new cost structure of the company. At current levels and no change in estimates there is 11-23% upside to the stock.

 

SBUX – PROVING RESILIENT AFTER ALL - sbux4

 


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