Stock of the week: Starbucks

Summary:

• Starbucks (SBUX.US) signed awaited deal with Nestle (NESN.CH)

• The coffee company maintains robust pace of store openings

• Stock managed to regain more than half of late-June’s drop

Interesting news concerning Starbucks (SBUX.US), an American coffeehouse chain, has surfaced lately. While the story may not be new at all, the latest announcements definitely make coffee company situation more clear and herald an increased revenue in the years to come. In this analysis we take a look at the deal finalized by the company lately, as well as at its most recent earnings report.

While Starbucks enjoyed a solid number of retail outlets for several years the dynamics of opening new locations (black line on the chart above) accelerated significantly after 2010 reflecting company’s broader expansion outside of the US. Source: Bloomberg

So, what happened? Nestle, the Swiss food company, and Starbucks announced this week that they have finalized the licensing deal worth $7.15 billion that was announced earlier this year. Following signing of the agreement Nestle obtained perpetual rights to sell and market packaged products of Starbucks and its subsidiaries, among which one can find famous Seattle’s Best Coffee or Teavana. While direct impact of the deal on Starbucks in terms of one-off payment for the rights to sell its products as well as revenue streaming from royalties and fees is quite clear, there are more benefits than that. Starbucks is an established brand in the US and other developed countries around the world. Nevertheless, its worldwide presence may be greatly boosted through cooperation with Nestle. While 70 countries that Starbucks operates in may look as quite a solid number at the first glance, it looks rather small compared to 189 countries Nestle is present in. Having said that, a deal with Nestle can be viewed as an opportunity to use the Swiss company’s well established channels to promote Starbucks brand in parts of the world that were “unknown” to Seattle-based coffee company before. Given that the core business of Starbucks are retail coffee outlets such promotion may make it easier to open cafes in new markets and succeed there. Apart from that, it can be viewed as cost reduction for coffeehouse chain as establishing and maintaining its own international distribution chain is clearly costly. The key advantage of the deal in this field is that while the costs of distributing packaged products are most likely to decrease for Starbucks, the revenue from sale of these products has a great chance to increase because of Nestle’s position as the largest food company in the world.

Taking a look at the Starbucks earnings and revenue one can spot that a seasonal pattern is present with the first quarter of the calendar year being the worst for the company. Source: Bloomberg

The company enjoyed stable revenue growth throughout past years and the latest earnings report for the second (calendar) quarter of 2018 proved that situation did not change. The company managed to boost its sales by 11.46% throughout the past year. The presence of operating profit (EBIT) on the chart above instead of net profit is not unjustified. The operating profit shrinked by 0.57% against the same period in 2017 showing that the company’s operating margin squeezed. In case net profit was presented on the chart such a decline would not be visible as tax overhaul passed at the end of 2017 would offset smaller margins. While for some a decrease in operating margin may be viewed as a worrying sign, commentary released along with earnings definitely bodes well for the company. Namely, Starbucks said that it managed to increase the pool of active members in its loyalty programs by 14% YoY to a total of 15.1 million members and that average spending per visit rose by 3% YoY. However, what one may find interesting is the fact that revenue is subject to seasonality. On the chart above one can spot that the first quarter of the year is characterized by a drop in sales figures.

After a significant slump in late-June following Starbucks’ announcement that the company plans to close over hundred stores next year the share price climbed back to the price zone ranging $52.60-53.50. Do notice that the stock still trades well below its long term moving average (200SMA, purple line) as well as descending trendline. Source: xStation5