Starbucks Brews Up Impressive Earnings But Falling Margins a Worry

by Trefis Team
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Starbucks (NASDAQ:SBUX) delivered strong results last week on the back of strong revenue growth. The company changed its reporting format from this quarter to include the results of China & Asia Pacific (CAP), Americas and Europe, Russia, Middle East and Africa (EMEA) separately. Total revenue grew by 16% to $3.44 billion, compared to the same quarter previous year. Revenue growth was partially helped by the addition of Evolution Fresh and the conversion of some of the outlets in Europe which were running as joint ventures to company-owned outlets and recognizing full revenue from packaged coffee and tea sales under the direct distribution model. The company posted a net income of $382 million or 50 cents a share up more than 10%. Starbucks’ competitors in the broader market for coffee include McDonald’s (NYSE:MCD), Caribou Coffee (NASDAQ:CBOU) and Dunkin’ Brands (NASDAQ:DNKN).

See full analysis for Starbucks here

Margin Outlook is Concerning

Although the results sound impressive, a closer look at the earnings reveals that operating margins are under pressure primarily due to higher cost of raw materials. In all of the segments the company reported the Cost of Goods Sold (COGS) as a percentage of revenues has increased. In CAP and EMEA regions, COGS now constitutes close to 50% of the total revenues. Starbucks acquires coffee through fixed-price contracts and price-to-be-fixed contracts. The price for the latter has to be determined by either the company or the supplier. Should the prices rise in the near term, the company’s profit margins could be squeezed further.

As mentioned, the revenues showed strong growth but they are inflated because of revenue addition from Evolution Fresh, the conversion of certain joint venture outlets to company-owned stores and the recognition of full revenues from tea and coffee sales. Discounting these three revenue additions, we find that the revenue growth actually comes out to be less than 8%. We are cautious on the stock at the moment since we expect the growth of expenses to outpace the revenue growth which will reduce profitability.

We have a Trefis price estimate of $40 for Starbucks, which is around 15% below the current market price. We are in the process of revising our estimates to incorporate Q4 earnings.

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