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Should I Own Starbucks? 3 Pros, 3 Cons

Starbucks blew past its Q3 earnings expectations

   

Starbucks (SBUX) blew past its 52-week high Friday morning after reporting yesterday that it had topped third-quarter revenue and earnings expectations. After delivering its best Q3 performance in its 42-year history, the coffee dynamo seems unstoppable.

Nonetheless, with SBUX trading at an all-time high, it raises the question: Should you buy Starbucks, or wait for it to cool? To decide, here are three pros and three cons.

Pros

Earnings: CFO Troy Alstead said it best:

“Our ability to grow income at a pace that exceeds revenue growth clearly demonstrates the strategic synergies we generate across our global footprint, which combined with the diversity of our portfolio, enables consistent delivery of excellent results. Looking forward to FY14 and beyond, I am as confident as ever in our ability to continue to deliver strong revenue and earnings growth.”

Any time you can deliver 8% same-store sales growth on a global basis you’re doing just fine. It also doesn’t hurt when you boost operating margins by 150 basis points, increase operating profits by 25% and diluted earnings per share by 28%. Heck, even the company’s Europe, Middle East and Africa segment showed positive comp growth in Q3.

Strength Without La Boulange: Its 2012 acquisition continued to pay dividends in June as its baked goods were rolled out in Seattle, Portland and Spokane. It now has La Boulange products in 1,076 stores, which represents about 10% of its U.S. total. The full integration of baked goods is expected to be completed by mid-2014. The cynic might say that it’s been more than a year since it announced the acquisition and yet only 10% of the stores have the new product — but if you read about the process in the San Francisco Bay area, I think you’ll see why. The integration will speed up as it figures out the fridges, etc. Having such a phenomenal quarter despite minimal contribution from La Boulange is definitely a big positive.

Vertical Integration: Starbucks now has two Evolution Fresh stores open in the Seattle area with another opening in San Francisco by the end of 2013. More importantly, it’s opening a juice manufacturing plant in southern California that will boost Evolution’s production five-fold. That’s a good thing because Evolution Fresh ready-to-drink juices are now in 800 stores on the West Coast, and that number is expected to double before the end of the year. Starbucks continues to find ways to bring more of the products it offers in its stores in-house where the margins are higher. Look for it to make more tuck-in acquisitions where appropriate.

Cons

U.S. Comps: In the Q3 conference call, Troy Alstead was asked about the slowing growth in its domestic stores. Essentially, while growth still will be in the mid-single-digit range in the fourth quarter, its U.S. stores were beginning to show some weakness in June and July. With the U.S. stores representing such a big part of its overall business, any slowdown without a corresponding increase in one of its other regions would result in lower comp growth overall.

EPS Growth: Starbucks expects its EPS growth in 2014 between 18% and 22%. Goldman Sachs analyst Michael Kelter questions how the company can predict such strong growth when it wasn’t able to see the slowdown at stores across the U.S. in June. Although Asia-Pacific is becoming an increasingly important part of its business; its overall strength rises and falls in the U.S. If it can’t deliver at least 150 basis points in operating margin improvement next year, it’s going to be very difficult for the company to hit its guidance.

La Boulange: I’ve read numerous rumblings online from both Starbucks and La Boulange customers about the quality of the product. After all, the company is mass-producing croissants and then immediately freezing them to hold in the flavor, then shipping them out to the stores where they’re reheated. If you’ve ever eaten frozen vegetables you probably can relate to this complaint because they never taste nearly as good out of the freezer as they do out of the ground. Sure, the nutrients are locked in by freezing, but that doesn’t make them taste better. If the company doesn’t figure out how to eliminate this problem — La Boulange could be an expensive mistake.

Verdict

Yesterday I wrote about quick-service and fast-casual stocks. I came to the conclusion that Chipotle (CMG) and Noodles & Company (NDLS) were the best stocks to own. I briefly mentioned Starbucks but didn’t seriously consider it because to me it’s still a beverage business despite the moves it’s made in the past year.

And that’s what makes its future so bright. It’s growing same-store sales mid-single digits in the U.S. when 61% of Americans believe the economy is still in the tank. It’s coming up with new product ideas like its Refreshers line of cold beverages that use coffee innovation to drive revenues and its food business is still in the early stages of development. Yet investors have barely noticed. Despite generating the some of the best results in the company’s history, its stock has gained just 27% over the past 52 weeks. To me, that spells value.

Howard Schultz made the mistake of getting complacent once before, and Starbucks paid the price. He’s not going to do it again. It’s full speed ahead until he finds someone who can deliver the same passion for the business. Like Tesla (TSLA), it’s thinking about and doing stuff that wannabe’s like Panera Bread (PNRA) can only dream of.

Should you own Starbucks stock? You’d better believe it.

As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2013/07/should-i-own-starbucks-3-pros-3-cons/.

©2014 InvestorPlace Media, LLC

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