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Shares of Starbucks Corporation SBUX fell almost 3% in after-hours trading as its third-quarter fiscal 2016 sales growth disappointed investors. Sales were primarily hurt by slow down of comps and traffic trends in the flagship U.S. market, in the quarter.
The disruption brought on from the changes in the rewards program and its negative impact on one of the most popular yearly promotion, Frappuccino Happy Hour, affected sales in the U.S.
The Seattle-based coffee giant also curtailed its full-year issued sales and comps outlook.
Earnings In Line
Adjusted EPS of 49 cents were in line with the Zacks Consensus Estimate as well as management’s expected range of 48–49 cents.
Earnings grew 17% year over year as strong margins and lower-than-expected taxes offset slow sales growth. Traffic trends slowed down globally.
Earnings have been adjusted to exclude certain costs related to the purchase of Starbucks Japan in 2014, gain on sale of Germany retail operations to an existing licensed partner in the quarter and some other tax-related items.
Sales & Comps Slow Down
Total third-quarter sales of $5.24 billion increased 7% year over year. Revenues, however, missed the Zacks Consensus Estimate of $5.35 billion by 2.1%. Higher sales in China and the Channel Development segment counterbalanced a slowdown in sales growth in the U.S. and Europe.
Same-store sales (comps) grew 4%, less than 6% the previous quarter, due to cooling global traffic trends. Global traffic was flat in the quarter, less than the 2% increase in the previous quarter. Average ticket growth remained unchanged at 4% in the reported quarter.
Adjusted operating margin rose 30 basis points (bps) year over year to 19.8% as improved sales leverage and lower commodity costs, mainly coffee, offset higher employee and digital investments, mainly in the Americas segment.
Americas: Net revenue in this flagship segment rose 7% year over year to $3.65 billion.
Comps rose 4% in the quarter, less than 7% last quarter due to softer traffic trends, which in turn, were flat in the quarter, less than 3% in the previous quarter. In the U.S., comps increased 4%, less than 7% in the previous quarter due to soft traffic trends. Sales grew 8% in the U.S.
Importantly, the comps growth in the U.S. went below 5%, thus ending its impressive streak of 25 straight quarters of comparable-store sales growth of 5% or greater.
As warned at the second-quarter conference call, Starbucks’ U.S. comps in the third quarter were hurt by the April overhaul of its Starbucks Rewards program from a frequency-based model to a spend-based one. According to this update, customers now receive rewards for every dollar spent at its stores rather than the number of visits.
The shift to the new rewards program also disrupted the normal cadence of the summer marketing campaign, Frappuccino Happy Hour promotion, which had generated higher revenues last year.
At the call, management also stated that the political uncertainty and the ‘’profound weakening in consumer confidence’’ has hurt overall restaurant traffic trends in the country. Also food sales in the company’s stores slowed down in the quarter.
Food sales grew 10% year on year and contributed 1% to comps growth which slowed from 2% in the previous quarter. Breakfast sandwiches, however, continued to do well with sales rising 20% year over year.
Core beverages platform, excluding blended, contributed only 2% of comp growth due to lower than expected sales of Frappuccino in the quarter. The cold beverage platform, however, did well in the quarter. Iced beverage revenues, excluding blended, grew 25% in the quarter.
Tea contributed 1 point to comps growth fueled by higher sales of Teavana handcrafted tea beverages in Starbucks stores.
Notably, despite the change to the rewards program Starbucks added approximately 2 million new members in the My Starbucks Rewards (MSR) program in the quarter, up 18% year over year. In the U.S. and Canada, the company now has 12.3 million MSR members.
Adjusted operating margin declined 40 bps to 24.6% as strong sales leverage and lower costs of sales were offset by higher employee and digital investments.
Europe, Middle East and Africa (EMEA): Net revenue declined 7% year over year to $273.4 million due to currency headwinds and portfolio shift to licensed stores including sale of the Germany store. Excluding currency headwinds and portfolio shift, sales grew 5%.
Comps declined 1%, comparing unfavorably to an increase of 1% last quarter due to a slowing economy, Brexit related political uncertainty and recent terror attacks in the region.
Adjusted operating margin (excluding cost incurred on sale of Germany operations) declined 20 bps to 12.0% due to weak sales.
China-Asia-Pacific (CAP): Net revenue rose 18% to $768 million on strong sales growth in China.
Comps grew 3%, same as in the previous quarter as strength in China was offset by softer comps in Japan. Though comps were positive in Japan, they were upset by recent earthquakes and economic slowdown in the country.
China comps rose 7% in the country driven almost entirely by increased traffic trends.
Adjusted operating margin at the CAP segment rose 90 bps year over year to 25.6% as strong sales leverage and higher JV income counteracted currency headwinds. Excluding Fx, CAP margins expanded by 210 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.
Channel Development had a very strong third quarter. Net revenue grew 9% year over year to $441 million, on the back of higher sales of Starbucks-branded K-Cup offerings and increased foodservice and packaged coffee sales. The international CPG business also did well.
Adjusted operating margin increased 710 bps to 43% driven by higher profits from the North American Coffee Partnership (NCAP) with PepsiCo, Inc, PEP, lower coffee costs, improved cost of goods sold efficiency and decreased marketing spend.
Starbucks formed the NCAP joint venture with Pepsi in 2014 for marketing, sale and distribution of Starbucks ready-to-drink coffee and energy beverages. The joint venture has grown into a more than $1.5 billion retail business offering 40 ready-to-drinkStarbucks beverages at present.
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 5% to $110.1 million.
Fiscal 2016 Outlook
While the company lowered its sales expectations, the profit expectation remained intact. The guidance includes an extra 53rd week in fiscal 2016.
Excluding the extra week, Starbucks expects revenues to grow approximately 10% in the fiscal year compared with more than 10% expected earlier.
The extra week is projected to add roughly 2% to sales. Currency impact is likely to hurt revenues by 1% (previously 1% to 2%).
Comps are expected to grow in a mid-single-digit range, comparing unfavorably with the previous guidance of somewhat above the mid-single-digit range. The company expects to open 1,900 stores in the year, up from 1,800 expected previously.
Starbucks earlier maintained its 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. The guidance includes contribution from the extra week, which is expected to add 6 cents per share in the fourth quarter. The guidance represents 19–20% EPS growth.
Adjusted operating margin is expected to increase slightly year over year. Currency impact is likely to hurt operating income by approximately 2% (previously 2–3%).
Fourth-Quarter Outlook Issued
Adjusted earnings per share are expected in the range of 54–55 cents, in line with the Zacks Consensus Estimate of 55 cents. This represents a growth rate of 26–28%. Global comps growth is expected to be 5% as management remains positive about a little improvement in the U.S.
Stock to Consider
Starbucks slumped to a Zacks Rank #4 (Sell) after the earnings release. Investors interested in the restaurant sector may also consider stocks like Dave & Buster’s Entertainment, Inc. PLAY and Chuy’s Holdings, Inc. CHUY. Both stocks sport a Zacks Rank #1 (Strong Buy).
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