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Starbucks (SBUX) Q2 Earnings in Line; Sales, Traffic Decline

Shares of Starbucks Corporation SBUX fell almost 4% in after-hours trading as its sales growth disappointed investors in the second-quarter fiscal 2016 as global traffic trends slowed.

The coffee giant maintained the previously issued sales guidance for fiscal 2016 but raised the lower end of its earnings per share (EPS) guidance by a penny.

Earnings in Line

Adjusted EPS of 39 cents were in-line with the Zacks Consensus Estimate as well as management’s expected range of 38–39 cents.

Moreover, earnings grew 18% year over year. The upside was driven by year-over-year increase in sales and margins. However, global traffic trends slowed down in the quarter.

Sales Slow Down

Total second-quarter sales of $4.99 billion increased 9% year over year. Revenues, however, missed the Zacks Consensus Estimate of $5.017 billion by 0.5%. Higher sales in China and the U.S. offset a relatively softer performance in Europe.

Same-store sales (comps) grew 6%, less than 8% the previous quarter, due to cooling global traffic trends. Global traffic rose 2% in the quarter, less than 4% increase in the previous quarter. Average ticket growth remained unchanged at 4% in the second quarter.

Margins Increase

Adjusted operating margin rose 30 basis points (bps) year over year to 17.6% as improved sales leverage offset higher employee and digital investments. However, operating margins declined 230 bps sequentially.

Segment Details

Americas: Net revenue in this flagship segment rose 10% year over year to $3.46 billion.

Comps rose 7% in the quarter, less than 9% last quarter due to softer traffic trends, which in turn, grew 3% in the quarter, less than 4% in the previous quarter. In the U.S., comps increased 7%, less than 9% in the previous quarter due to soft traffic trends.

Strong morning day part performance, growth for core coffee/espresso platforms and higher food and tea sales provided some support in the quarter.

Food sales surged 16% year on year and contributed 2% to comps growth backed by strong performance of breakfast sandwiches and lunch offerings. Sales of Bistro Boxes (lunches) went up 18%, while that of breakfast sandwiches soared nearly 30% year over year.

Tea sales improved 17% in the quarter and contributed 1 point to comps growth fueled by higher sales of Teavana handcrafted tea beverages.

Continued benefits from digital initiatives also boosted sales in the quarter. Moreover, the company added 1 million new members in the My Starbucks Rewards (MSR) program. In the U.S., the company now has 12 million MSR members, up 16% year over year.

In April, Starbucks updated its rewards program. According to the update, customers will receive rewards for every dollar spent at its stores rather than the number of visits.

Starbucks is introducing many technological innovations to strengthen its brand, improve efficiency and in-store execution and thereby, boost profitability.

The company’s latest digital initiative, Mobile Order and Pay, is witnessing increased usage and could prove to be a key growth driver in 2016 as adoption increases. This initiative allows customers to order before arriving at a Starbucks café and pick up the items at their preferred Starbucks outlet, thus saving time. The company currently processes over 8 million transactions every month. At the earnings conference call, management said that Mobile Order and Pay transactions represented approximately 4% of total transactions in the quarter, up 40% sequentially.

Starbucks started food and beverage delivery service through its employees at New York’s Empire State building last October. The company also began testing food and beverage delivery in collaboration with on-demand delivery service, Postmates, in a few areas of Seattle last December.

These initiatives are expected to quicken service, increase convenience and enhance customer loyalty, thereby driving mobile payment transactions and in turn, traffic.

Adjusted operating margin improved 80 bps to 23.5% as strong sales leverage, lower costs of ingredients — mainly dairy — offset employee and digital investments.

Europe, Middle East and Africa (EMEA): Net revenue declined 4% year over year to $268.3 million due to currency headwinds and portfolio shift to licensed stores. Comps grew 1%, same as last quarter due to a challenging macroeconomic environment.

Adjusted operating margin declined 10 bps to 10.3% due to difficult year-ago comparisons, which included gains from certain asset sales. Excluding the gains and Fx impact, margins expanded slightly.

China-Asia-Pacific (CAP): Net revenue rose 14% to $677.9 million driven by store openings.

Comps grew 3%, less than 5% in the first quarter, weighed down by the addition of the Japan business into the CAP comp calculation.

The company gained 100% ownership of its Japanese joint venture (JV) — Starbucks Coffee Japan, Ltd. — in first-quarter fiscal 2015. We would like to remind investors that this is the second quarter in which the acquired stores in Japan were included in the global comp base.

China revenues grew 18%, while traffic rose 5% in the country.

Adjusted operating margin at the CAP segment rose 20 bps year over year to 21.0% as strong sales leverage and higher JV income offset currency headwinds and higher store operating costs. Excluding Fx impact, margins rose 110 bps.

Channel Development/CPG: This segment includes roasted whole bean and ground coffees, premium Tazo teas, a variety of ready-to-drink beverages (like Frappuccino and Starbucks Refreshers) and Starbucks and Tazo branded K-Cup packs sold through channels such as grocery, specialty retailers, and foodservice to name a few.

Net revenue grew 8% year over year to $461.2 million, primarily due to higher sales of Starbucks-branded K-Cup offerings and foodservice business.

Adjusted operating margin increased 300 bps to 39.5% driven by higher profits from the North American Coffee Partnership with PepsiCo, Inc, PEP, lower coffee costs and improved cost of goods sold efficiency.

Starbucks announced plans to sell Starbucks-branded Nespresso compatible pods in Europe later this year. Moreover, the company has plans for single-serve markets across CAP and in China.

All-Other: The segment comprises emerging brands including Teavana (acquired in Dec 2012), Seattle's Best Coffee, Evolution Fresh and Digital Ventures. Revenues in the segment dipped 1% to $130.2 million.

Share Buybacks

Starbucks repurchased 23 million shares in the second quarter and announced another 100 million share authorization.

Fiscal 2016 Outlook

Starbucks expects revenues to grow more than 10% in the fiscal year, excluding the 53rd week. The extra week is projected to add roughly 2% to sales.

Comps are expected to grow somewhat above the mid-single-digit range. The company expects to open 1,800 stores in the year — 700 in the Americas, 200 in EMEA and 900 in CAP.

Starbucks tightened the previously issued fiscal 2016 guidance. For fiscal 2016, the company now expects adjusted earnings (including the 53rd week) in the range of $1.88–$1.89 per share as against $1.87–$1.89 per share expected previously. The guidance includes contribution from the extra week, which is expected to add 6 cents. The guidance represents 19–20% EPS growth, slightly up from 18–20% projected previously.

Adjusted operating margin is expected to increase slightly year over year as strong top-line performance, sales leverage and improved operational efficiency will be partially offset by accelerated global employee and digital investments.

Currency impact is likely to hurt revenues by 1–2% (previously 2%) and operating income by 2–3%.

Management expects employee and digital investments to be between $275 million and $300 million in fiscal 2016, higher than nearly $145 million in 2015.

Commodity costs are expected to have a slightly favorable impact on 2016 profits. Starbucks has locked nearly 100% of its coffee costs at favorable prices for fiscal 2016. This should help in expanding margins.

Effective tax rate for 2016 is expected to be approximately 34% (previously between 34% and 35%). Capital expenditures in fiscal 2016 are likely to be approximately $1.4 billion.

Third-Quarter Outlook Issued

Adjusted earnings per share are expected in the range of 48–49 cents, in line with the Zacks Consensus Estimate of 49 cents. This represents a growth rate of 14–17%.

Management warned that the comps growth in the third quarter can be hurt by the April overhaul of its Starbucks Rewards program.

Stocks to Consider

Starbucks has a Zacks Rank #2 (Buy). Investors interested in the restaurant sector may also consider stocks like Dave & Buster's Entertainment, Inc. PLAY and Carrols Restaurant Group, Inc. TAST. Both the stocks sport a Zacks Rank #1 (Strong Buy).

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