Hedgeye - SBUX | WHAT WILL SLOW THEM DOWN?

HEDGEYE COMMENTARY

SBUX is a juggernaut!

The company reported a very strong end to FY15 quarter and looks like FY2016 will be another strong year. In the US, food sales are accelerating and Mobil Order & Pay is driving incremental transactions. Globally, the company is growing same-store sales and adding more stores to the base.

The bar was set high coming into this quarter and now has been set even higher going into 1Q16. Despite the company providing EPS guidance slightly below street estimates, the trend in transaction growth, which is the most important metric, points to continuing growth.

The quote by CEO Howard Schultz says it all “Starbucks occupies a front-row seat at the intersection of the physical and digital worlds like no other company anywhere in or out of retail.” Mobile Order & Pay is the key to driving future growth at SBUX. On the other side of the coin, I do not believe that the trends we are seeing in food sales have long-term sustainability.

Currently the stock is trading at 18.13x EV/NTM EBITDA, which puts SBUX at a significant premium to its global peer group. While it may deserve the premium, the stock is priced for perfection and nothing lasts forever.

4Q15 CALL - MANAGEMENT COMMENTARY

GLOBAL COMP STORE SALES - Starbucks same-store sales increases of 8% globally, 9% in the U.S., a 4% increase in global traffic. 4Q15 represented the 23rd consecutive quarter of global comp store sales growth of 5% or more. The company served over 72mm more customer occasions from our global comp store base than we did the year before
REVENUES AND EPS - 4Q15 reported revenues of $4.9B and non-GAAP EPS of $0.43 FY15 revenues of $19.2B and non-GAAP EPS of $1.58

STRATEGIES

Partners - And the investments we make in our partners pay tangible dividends in the form of more satisfied and engaged partners, deeper connections among partners, and with customers and improved in-store efficiency, all of which contribute to an elevated in-store Starbucks experience for everyone, partners and customers alike. Noteworthy is that today we are seeing improvements in partner attrition, a direct result of our partner investments at a time when the industry overall is actually moving in the opposite direction
Our comp results are strongest where we are having our greatest success in reducing turnover
And our newest class of stores is performing at the highest level in our history, generating first-year average unit volumes of $1.4mm, up nearly 20% from only three years ago, while also delivering record profitability and returns on investment
At the same time, we continue to open new Starbucks stores and introduce dynamic new best-of-class store designs and formats like our express stores and drive-thrus, while meaningfully growing comps and without any net cannibalization of existing Starbucks stores operating in the same trading area
Starbucks occupies a front-row seat at the intersection of the physical and digital worlds like no other company anywhere in or out of retail

PARTNERSHIPS

The partnerships we’ve recently announced with The New York Times, Spotify and Lyft are the first of many partnerships that will enable us to increasingly leverage and monetize the platform and our other technology investments
Through these investments and the best-of-class mobile and digital experience that Starbucks delivers, we believe that we are building an unassailable position that will only strengthen and become more relevant as today’s increasingly mobile-first consumer economy evolves

NEXT-GENERATION OF FEATURES AND MOBILE PAYMENT

But despite our industry-leading position in mobile and digital today, we are continuing to push the envelope and now have line of sight on the next-generation of features to excite and delight our customers and our partners
Mobile payment now accounts for 21% of all transactions in our U.S. company-owned stores, and although we only completed the rollout of Mobile Order & Pay across our system 7500 U.S. company-owned store portfolio in September, we were already operating at a run rate of over five million transactions per month
We have seen the pattern of accelerated adoption of Mobile Order & Pay with each successive region and market we enter play out over and over again. And I’m pleased to report that we are seeing it again in terms of this pattern, accelerated adoption, repeat in the early days of our recent international launches of Mobile Order & Pay in both the U.K. and Canada
My Starbucks Rewards Program
Membership in our fast growing and industry-leading My Starbucks Rewards program, our loyalty program, continues to grow, and we now have over 20mm members in countries around the world
And two weeks ago, we launched delivery in the Empire State Building to favorable customer and media response, and we’ll be launching delivery in Seattle in conjunction with Postmates later this quarter
We have begun deployment in 150 stores in the U.K. and more than 300 stores in Canada, while framing plans to continue rolling out Mobile Order & Pay in key markets around the globe
We launched the Starbucks mobile app, both the iOS and Android versions in France and Germany
We’re on track to deploy in Poland, Czech Republic, and Kuwait this year

Kevin R. Johnson, President and Chief Operating Officer, Starbucks Corp.

OPERATING HIGHLIGHTS

REVENUES, BEVERAGE PROGRAM AND SALES

Americas posting 4Q15 same-store sales of 9% and revenues growth of 11%. In Fy15 it opened 612 net new stores over. “Our beverage program, fueled by innovation such as our new Cold Brew and strong core beverage performance, drove six points of comp growth and delivered increased food attach rates.
Sales of iced beverages, including Teavana Shaken Iced Teas, grew 20% YoY
And our limited-time offering line-up with the new and improved Pumpkin Spice Latte, Salted Caramel Latte, and Toasted Graham Latte performed well ahead of our initial expectations
FY2015 Teavana branded tea beverages generated nearly $1B of sales through Starbucks stores in the U.S., up 12% over last year
And we will be bringing Teavana branded, handcrafted tea beverages to CAP and EMEA in FY2016
Food revenue grew 19% in the quarter, contributing three points of comp growth, including attach
Our breakfast sandwich platform, which has now doubled in size from just three years ago, is increasingly resonating with our customers, and our lunch program is accelerating
You may recall that last year, one in seven Americans received a Starbucks Gift Card over the holidays, generating over $1.6B in card loads in our Q1 FY2015This year, we’ve reimagined our card mall, expanded the program to include all U.S. company operated stores, and we’re introducing a limited offering of premium cards We’re also bringing back the opportunity for customers to win something that isn’t for sale: Starbucks for Life
Noteworthy is that total card loads in the U.S. and Canada, including reloads and activations, in FY2015 totaled $5.1B, up 19% year-on-year

CHINA ASIA-PACIFIC SEGMENT

China Asia-Pacific segment delivered comp growth of 6%, driven entirely by increased traffic, with revenue growing 110% or 18% excluding the impact of approximately $287mm from the ownership change in Starbucks Japan and negative impact of FX. Operating income grew 25%
Store growth continues with 838 net new stores in FY2015. The new class of company-operated stores in CAP is outperforming the prior class, generating record AUVs and profit, results that demonstrate the accelerating strength and relevance of the Starbucks brand across the region.
There are now over 1,800 stores in 95 cities throughout China
There are over eight million MSR customers in China, giving confidence to having 3,500 stores in China by the year 2019
Traffic growth in China continues to outpace CAP segment traffic growth overall.
Traffic comps in China accelerate throughout the quarter with continued strong momentum into October
Japan delivering another solid quarter of comp sales growth
And now with full ownership, SBUX will accelerate growth and leverage all mobile and digital capabilities
Company operated stores we acquired in Japan last year will be included in the global and CAP comp basis during Q1 FY2016

EMEA’s

Excluding approximately $40mm of FX headwinds and the transfer of 41 stores from company-owned to licensed, EMEA revenues increased approximately 8% in Q4
Every major EMEA market posted positive comps in Q4, with the U.K., France, and Germany posting particularly strong comp growth
Comparable store sales in EMEA grew 5% despite ongoing macroeconomic challenges in several markets in the region with a 3% increase in traffic, representing EMEA’s 10 consecutive quarter of positive comp growth
EMEA licensed markets are continuing to perform exceptionally well, with Turkey and the Middle East in particular continuing to outperform, further supporting our license-focused growth strategy
By Q4, nearly 69% of our 2,362 EMEA stores were licensed, up from only 54% four years ago
EMEA delivered 37% increase in operating income over Q4 last year

CHANNEL DEVELOPMENT REVENUE GROWTH

Channel Development Q4 revenues grew 14% over last year to $457mm
Continued competitive pressures in at-home coffee categories
Pleased with the strength of packaged coffee sales in the quarter, which combined with K-Cup sales were the primary drivers of Channel Development revenue growth?
Total K-Cup portfolio continues to gain share despite increased pricing pressure and additional new market entrants
Starbucks is now the share leader in both premium roast and ground and the entire K-Cup segment for Q1 ever
Stars down-the-aisle loyalty program driving incremental purchases of roast and ground in FY2016, and expanding the Stars program to include select Starbucks K-Cup SKUs
Foodservice saw 8% revenue growth YoY
Internationally, we’re seeing strong growth in the China Asia Pacific ready-to-drink sales
On track to launch ready-to-drink through grocery and convenience store channels in 10 Latin American markets with our long-term business partner, PepsiCo, in 2016

MSR CUSTOMER

This quarter the active MSR customer base in the U.S. increased by 28% year-on-year and active mobile users in the U.S. and Canada has grown 32% year-on-year
Mobile payments in October represented over 21% of U.S. tender
Launching Delivery Pilots in New York City and Seattle
In the coming weeks, going to launch a rich digital music experience, both in-store and out of store, integrated in our mobile app through our partnership with Spotify

Scott Harlan Maw Executive Vice President and Chief Financial Officer, Starbucks Corp.

FINANCIAL HIGHLIGHTS

GAAP operating margin in Q4 was 19.7% and non-GAAP operating margin was 20%, up nicely from Q3, but down 50BPS from Q4 of last year, due to the impact of partner and digital investments and the change in ownership of Starbucks Japan, partially offset by sales and cost of goods sold leverage
In Q4, Americas’ operating income increased 13% y-over-y to $840mm – $841mm on an 11% increase in revenues to $3.4B.
Americas operating margin expanded 40BPS to 24.8%
Strong sales leverage resulting from a 9% increase in U.S. comps was the primary driver of the margin expansion, more than offsetting approximately 160BPS of impact related to increased partner and digital investments in Q4
GAAP operating income in our CAP segment reached a record $130mm in Q4, a full 25% increase over the prior year
CAP GAAP operating margin declined to 19.9% from 33.5%, primarily due to the impact of the ownership change in Starbucks Japan
Excluding the 15.5 percentage points of financial impact from the ownership change in Starbucks Japan, CAP’s operating margin increased by 190BPS, driven primarily by operating savings in the region
EMEA results in Q4 were particularly strong, once again demonstrating increasing momentum in the business and continued progress against our plan to significantly improve segment profitability over time
EMEA achieved record operating income for the quarter, and when excluding unfavorable FX impact of nearly $5mm, EMEA operating income increased by almost 50% y-over-y to $58mm
And EMEA’s Q4 operating margin of 17.2% exceeded expectations and marked the segment’s fifth consecutive quarter of double-digit operating margin
EMEA’s 510 basis point improvement in operating margin in Q4 over the prior year was driven primarily by sales leverage, including the impact of our ongoing portfolio shift to more licensed stores and gains on the sales of certain assets
Channel Development grew operating income of 15% over the prior year in Q4 to $197mm
Operating margin totaled 43.2%, a 20 basis point increase over the same quarter last year, reflecting a significant increase in income from our North America coffee partnership with PepsiCo and improved cost of goods sold efficiency, primarily offset by higher coffee costs and marketing costs
The effective tax rate for Q4 2015 reflects an incremental tax benefit related to certain additional domestic manufacturing deductions to be claimed in our U.S. consolidated tax returns These deductions are retroactive to fiscal-year 2010 and lowered our tax rate for Q4 of 2015 by 7.3% relative to Q4 of 2014, resulting in a GAAP effective tax rate of 27.2% for the quarter
FX negatively impacted both Starbucks’ revenue and non-GAAP EPS growth by roughly 3 percentage points in Q4 and 2 percentage points for the full year
In FY2015, returned a record $2.4B of cash to shareholders through a combination of dividends and share buybacks, up over 50% from 2014 levels
The board has approved a 25% increase in our quarterly dividend to $0.20 per share
After adjusting to reflect the change in ownership of Starbucks Japan, our return on invested capital increased over 200BPS in 2015

GUIDENCE

Consistent with our long-term goals, expect 10% or greater revenue growth on a 52-week basis with the 53rd week adding approximately two points to this growth
expecting 2016 global comp growth to be somewhat above our long-term mid-single-digit guidance range
Consolidated operating margin will increase slightly from 2015 on both GAAP and non-GAAP bases, reflecting strong revenue growth, sales leverage and increased operating efficiency and performance, partially offset by the impact of increased partner and business investments
Expect to see our operating margin in the Americas increase moderately above 2015, reflecting strong sales and COGS leverage, offset by the impact of our investments
Expect to see flat to slightly down operating margins in CAP from 2015 levels as increasing sales levels in China, Japan and across the region is offset by the last bit of impact from the acquisition of Starbucks Japan and the continuing impact of negative FX headwinds
Q1 CAP margin is expected to be lower by several points than Q1 of 2015, primarily due to lapping the impact of the change in our ownership of Starbucks Japan and the negative impact of FX.
FY2016 expect CAP comps to land in the mid-single digits, including the impact of adding over 1,000 stores in Japan into the calculation
And projected revenue growth in CAP will be in the mid-teens, reflecting excellent growth in all of our major markets and a small benefit from the change in Japan ownership, partially offset by ongoing FX headwinds
Expect our operating margin in EMEA to approach 15% for the year, as we continue to realize the benefits of increased momentum in key markets, strong execution by the team, and the ongoing business model shift from company-owned to licensed stores
And sales leverage will drive moderate margin expansion in our Channel Development segment, though less than the very strong 180 basis point expansion we saw in 2015
Expect GAAP EPS in the range of $1.84 to $1.86 and non-GAAP EPS in the range of $1.87 to $1.89, including the 53rd week we will report on in Q4 2016
the 53 week adds approximately $0.06 to our 2016 EPS estimate
Our expectations of comp growth being somewhat above mid-single digits is factored in to our 2016 EPS estimate
Expect the y-over-y increase in global partner and digital investments in 2016 will be between $100mm and $125mm, impacting our EPS growth rate by approximately 3 points
Our total global investment in these areas in 2016 will land between $250mm and $275mm, compared to approximately $145mm in FY2015
The majority of the 2016 initiatives will be in the U.S., but will also include global investments in certain increased partner benefits, digital and technology investments, and G&A costs
FX is expected to impact revenue growth by 1 percentage point and EPS growth by 2 percentage points
Commodities impact is slightly favorable for the year, now with over 90% of our 2016 coffee costs locked
And finally, our effective tax rate for 2016 will be between 34% and 35%
Given all these inputs, when adjusting our 2016 non-GAAP EPS range for the extra week by subtracting the $0.06, our growth rate vs. 2015 non-GAAP EPS of $1.58, will be at or slightly above 15%
For Q1, 2016 we are targeting GAAP EPS in the range of $0.43 to $0.44 and non-GAAP EPS of $0.44 to $0.45, representing a lower growth rate than the full year as significant FX headwinds in Q1 of 2016 will impact non-GAAP EPS growth by four full points
Given Q1, 2016 growth rate, we expect non-GAAP EPS growth in the remaining three quarters of 2016 to be in the middle of our long-term guidance range
Contributing to our revenue growth in FY2016 will be the addition of approximately 1,800 net new stores globally
In 2016, 70% of our net new stores will be outside of the U.S. with the entire Americas segment accounting for a total of 700 stores, split roughly evenly between company-owned and licensed
Our China/Asia Pacific segment will drive roughly half of our new store growth with 900 net new stores, two-thirds of which will be licensed
And our EMEA segment is targeting 200 net new stores in FY2016, virtually all of which will be licensed
Finally, CapExs in FY2016 are expected to be approximately $1.4B.
In 2016, Starbucks will deliver approximately $21B in revenue, operate close to 25,000 stores, and generate an operating margin approaching 20%

IMPORTANT COMMENTS FROM Q&A

“And I think if you go back a year ago, we were at 5% and 1%. And if you look at 9% and 4% in the U.S. and what we’ve done sequentially throughout the year and you couple that with the inherent momentum and attachment that we’re seeing from mobile payment, Mobile Order & Pay, and specifically the integration, as Kevin talked about, and the attachment of loyalty, we have enough visibility in the business to be transparent with you that we believe that we’re going to see some incrementality in our overall comp.”

“we’re seeing incremental transactions from Mobile Order & Pay, particularly in our busiest stores. We’re pleased with the results across all the tiers of our stores. You know, ticket right now is holding steady and is doing quite well consistent with our other MSR ticket, and we haven’t even added the feature of suggested selling and suggested pairing, which we’re going to do in H1. So, we expect to see that increase on top of the incremental transactions that we’re seeing.”

“In fact, if you look at the comps, three points of our comp growth came from food. Our breakfast sandwich business has doubled in the past three years. Lunch is accelerating.”

“We now have evenings program deployed in 100 stores, so it’s early days on evenings, but we’ve seen growth in every day part as a result.”

“On the beverage side, that accounted for 6% – six points of comp growth.”

“We know that MSR customers on average spend three times as much as non-MSR customers, and we’ve grown the number of active MSR customers by 28% year-on-year.”

“let me just be very clear that our business in China and across CAP remains very, very strong. We’ve seen no systemic slowdown in our business in China. In addition, what we saw during the quarter was that comps actually accelerated month to month. And in China, we see that comps are continuing to accelerate into the month of October”

“And when you break down the total growth across CAP and really across China, 75% of our revenue growth is being driven by new stores, 25% is being driven by comp, and what we continue to do is focus”

“The strength of breakfast sandwiches, as Kevin mentioned earlier, we’ve seen that business double over the last three years.”

“We’ve seen food grow through that 3% comp to 20% of the mix in U.S. stores, and we see that increasing over time to the mid-20%s, but obviously beverage will still drive it. And we’ll just keep investing, keep learning, and keep growing it.”

“Mobile payment is not going to become obsolete. Although mobile ordering is a form of mobile payment and we are going to see a significant number of transactions morph over.”

“In terms of data on percent of transactions or percent of tender that’s Mobile Order & Pay, since we just finished the rollout in the U.S. late in the quarter, we don’t have a full run-rate of quarter, so we’re still watching that advance. I think Adam gave you some color on some of the locations that are seeing high usage of that. But each wave of deployment we have made has been adopted faster than the prior wave.”

“This is Adam. Howard mentioned that we’re seeing a five million mobile order per month run-rate already. And while we’re not breaking out specific percentages, there is a range of mobile order numbers across a number of store tiers particularly in our busiest tiers and we are seeing significantly more incremental transactions, incrementality in our busiest stores. We are seeing, internationally, our latest wave that went out for Canada and U.K. saw even a faster adoption than the New York wave, which was faster than the previous wave. So we’re getting better at getting faster customer adoption and it bodes well for Mobile Order & Pay globally.”

Please call or e-mail with any questions.

Howard Penney

Managing Director

Shayne Laidlaw

Analyst

SBUX | WHAT WILL SLOW THEM DOWN? | CONFERENCE CALL NOTES