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After last quarter, I was somewhat concerned about the company’s ability to continue to surprise to the upside.  And, although SBUX reported an in-line quarter from an EPS standpoint after five consecutive quarters of earnings surprises, the reported 9% growth in U.S. same-store sales relative to the street’s 6.0% comp estimate did not disappoint. 

This 9.0% growth implies a 200 bp sequential improve in 2-year average trends (following the 250 bps of sequential growth in the prior quarter), which was driven entirely by better traffic trends as average check growth held steady on a 2-year average basis.  Traffic was up 6.0% in the quarter in the U.S., which is impressive in this current economic environment.  We will hear from MCD on Friday, but I would venture to say that even with the McCafe Frappes (smoothies were not launched until July) that MCD will not come close to matching Starbucks’ sequential improvement.  International same-store sales growth was up 6.0%, in line with expectations, and flat with the prior quarter on a 2-year average basis. 

U.S. operating margin was up 350 bps to 16.5%, in line with the street’s expectation, whereas International margin came in better than expected, up 280 bps to 10.9% (vs. street’s 9.4% estimate).  As I said after the second quarter, the rate of improvement will slow, but margin growth should continue to materialize from here.  To that end, SBUX is now guiding to the high end of its previously-stated 15%-17% U.S. operating margin range and expects another 100 to 150 bps of growth in FY11.  In the International segment, the company guided to 100 to 200 bps of margin growth in FY11 on top of the 8% to 10% range maintained for this year.  To be clear, these FY11 margin growth goals follow on about 600 bps of YOY growth in the U.S. in FY10 at the high end of the guidance and 180 to 280 bps in the International segment.

Starbucks continues to surprise but my biggest concern here is that expectations have caught up with the company.  Although the company raised its FY10 EPS guidance to $1.22 to $1.23 (from $1.19 to $1.22), the street was already at $1.23 going into the earnings report.  For FY11, SBUX guided to 15% to 20% EPS growth to $1.36 to $1.41 and again, the street is already at the high end of the range at $1.40.   

Howard Penney

Managing Director