Starbucks Corporation’s (NASDAQ:SBUX) stock has gained almost 15% in the last six months helped by a strong run of results and general optimism in the overall market. We believe the company’s operations are solid and that its strategy of expanding internationally while diversifying domestically is a good one.
At the same time, it is important not to get carried away by the recent sentiment. Digging deeper into some of the widely followed industry metrics for Starbucks reveals that the headline figures could be overstating its performance. While the overall aim of the article is not to disagree with the general consensus of its performance results, it is important not to overestimate the scope of future profitability. Here are some of the things to keep in mind:
1) Watch Out For Same-Store Sales
Starbucks’ same store sales growth came in at solid 7% for its American restaurants. The number is impressive, especially taking into account that Starbucks is a mature chain with close to 13,000 stores in the Americas region.  However, here’s the trick. Starbucks only reveals same-stores sales growth for its company-operated stores (i.e. there are no figures available for its licensed stores).
Moreover, sales of K-Cups and the Verismo brewers are included in its store sales. Now, since the Verismo brewers were introduced in its company-operated stores last year only and the distribution of K-Cups was expanded as well, these items inflated the comparable store sales figure versus last year.
An exact breakdown of the contribution of the brewers and the K-Cups isn’t available, but consider this hypothetical example. Suppose a store generated annual sales of $1 million in 2011. Therefore, its sales in 2012 were $1.07 million (i.e. 7% change). Out of the additional $70,000 sales, suppose $20,000 were contributed by the introduction of the Verismo and the expansion of K-Cups to new stores. Thus, discounting the sales of brewers and K-Cups, same-store sales growth would have been 5%.
Again, we emphasize that the example is just hypothetical. The breakdown could be 6% and 1% rather than 5% and 2% mentioned above. Nonetheless, it is a point worth taking into account. Going forward, it will be tougher for the company to maintain these figures unless it introduces new products regularly.
2) Margins Are Expanding… So What?
Starbucks’ operating margins widened to 15% in 2012 compared to 14.8% the year before. It’s pretty obvious that expanding is a good thing, but a greater mix towards licensed stores will tend to inflate the headline figure. For example, as of December 31, 2012, Starbucks had 48.2% restaurants globally which were licensed. The corresponding figure for 2011 stood at 47.3%. 
Although licensed stores have higher margins, they come at a cost. Only a fraction of the store sales are recorded on Starbucks’ income statement so the absolute value of the profits might still be lower than that of company-operated stores. If the trend of a greater mix towards licensed restaurants continues, expect the top-line growth to be weaker.
3) Is Channel Development Sales Growth Really That Good?
Sales of Starbucks’ channel development segment consist of packaged coffees and teas such as VIA Ready Brew, K-cups, and brewers, available in grocery and retail stores. With revenues of this segment totaling $1.3 billion in 2012, the division has begun to make a mark on the company’s income statement. 
However, Starbucks has transitioned from in-house retailing (i.e. retail through its own stores) to a direct distribution model (i.e. through groceries, warehouse clubs and drugstores) for its consumer packaged goods (CPG). Of the $432 million of incremental revenues in fiscal 2012, around $70 million was due to the benefit of recognizing full revenue from products under the direct distribution model. If you discount the impact of full year recognition, the growth would have been lower.
We have a $55 price estimate for Starbucks, which is slightly lower than the current market price.Notes: