Many consider Starbucks Corporation (NASDAQ:SBUX) and Nestle S A/S ADR (OTCMKTS:NSRGY) to be competitors. In some ways they are, with Nestle owning Nespresso and brands like Blue Bottle Coffee. But now they’re allies in some respects too, after agreeing on a $7.15-billion distribution deal.
So what’s going on here?
We don’t yet know how this deal impacts margins or EBITDA for either company at the moment. Starbucks said it expects the deal to be accretive to earnings in 2021, which seems awfully far off even after accounting for the transition period. For its part, Nestle management sees the deal adding to earnings in 2019.
The deal involves Nestle obtaining “the rights to market, sell, and distribute” Starbucks products, including Teavana and VIA products, outside of Starbucks locations.
SBUX will continue to roast and grind its own coffee used in the products, while Nestle will keep SBUX as a part of its single-serve product offerings — its Nespresso pods. Finally, Nestle will take on about 500 Starbucks employees as part of the deal.
What Does Starbucks Gain?
For full transparency, Starbucks is a very large single-stock holding for me. So on May 4, when shares were rallying on the rumblings of a potential sub-$4 billion after-tax deal with Nestle, it of course piqued my interest. On Monday, we got the news release, and I was eager for answers. Mainly, what does the deal mean for Starbucks stock?
For starters, the company will receive $7.15 billion in cash, a handsome sum no doubt. The company says this capital will be used to speed up its share repurchase program.
When Starbucks reported earnings at the end of April, management announced it would add another 100 million shares to its buyback program. Currently, the company has authorization to repurchase 124 million shares, good for roughly 9% of its outstanding share count.
A few quarters ago, Starbucks also bumped its dividend by 20%. In this regard, it’s clear the company is focused on returning capital to shareholders. It’s also clear that it wants to create value for its shareholders and streamline its business. It’s looking to do so by offloading a more cumbersome part of its operations and putting it in the hands of Nestle.
With Nestle, a much larger food conglomerate, Starbucks will no longer have to worry about marketing or distributing a bulk of its consumer packaged goods products (CPG). Instead it will “retain a significant stake as licensor.” While this will likely result in lower revenue and profit totals, it should benefit capital efficiency and margins.
One more positive? The move with Nestle can help Starbucks expand overseas from a CPG perspective. While SBUX has stores in Europe and the Middle East, it has very limited CPG exposure. This can help grow the brand abroad and boost SBUX’s licensing revenue.
Trading Starbucks Stock
SBUX stock was trading higher heading into the weekend on rumors of a potential deal. So when the figure came in at a pre-tax amount north of $7 billion — equal to almost 10% of its market cap — I was surprised that shares were not only muted in response, but actually fell!
Starbucks stock is now roughly flat for the week and well off its highs made on Monday.
I didn’t expect a post-earnings rally because, let’s be honest, SBUX has been stuck for much of the past three years. It has been a stock that rallies into earnings and falls after it reports. This is nothing new for long-term Starbucks investors.
However, I found last quarter more encouraging. After missing eight of the last nine revenue estimates, the company finally topped analysts’ estimates. U.S. same-store sales results came in ahead of expectations, and China is still strong. With a larger buyback announced, there wasn’t much not to like.
Now with the company speeding up that buyback on its deal with Nestle and streamlining its business, why sell Starbucks stock on this news?
In any regard, I think the deal is important for a few reasons. Aside from helping investor sentiment and increasing the strong bid under the stock, it may be what keeps Starbucks stock above the 200-day moving average. Without the deal, SBUX may have fallen back to its recent lows near $53. Instead, maybe it will retest resistance near $59.50.
Above that and we may (knock on wood) finally get the multiyear breakout we’ve been waiting for.