Starbucks Third Quarter Results Are Worrying

  • Starbucks meets earnings but misses on revenues and US comps growth. Caution is now warranted as the stock is not cheap.
  • The stock has support at the $54 level but if it breaks this, watch out.
  • China and a hefty increase in the company's loyalty program were positives for the quarter.

Starbucks (NSDQ:SBUX) met analysts estimates for earnings ($0.49) but missed on the top line ($5.24 billion reported compared to $5.33 expected) and the share price fell as a result after the earnings. It wasn't the earnings that was the defining factor though. It was the weaker than expected US same store sales growth which came in at 4%, 3% lower than the previous year.  The word "anomaly" was used to describe the reason for the company's decline in sales comps by CEO Howard Schultz. His reasoning was that the one time shift in the loyalty program affected the Frappuccino happy hour promotion which started back in May and will run through the Summer. "Breathing room" was the expression Schultz said Frappuccino needed which it obviously didn't get.

Furthermore, Schultz blamed the weak macro environment which resulted in lower than expected consumer spending, for the company's weak third fiscal quarter. As a result, management has now guided slightly lower growth rates which must be a concern.  China definitely proved to be a bright spot with its 7% sales comps growth but it wasn't enough to convince investors. So as investors, are we to believe management that this quarter's results were an "anomaly" or there is a new downward trend (see chart) taking place?

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Weaker Than Expected US Sales Comps Was The Story Of The Third Quarter

The US market is the bedrock of Starbucks. No matter what the other regions do, if the US doesn't grow, it is going to be reflected in the share price, period. In saying this, operating income grew to $1 billion which was up substantially from the $938 million of the same quarter a year ago. However the street wants sales comps growth and I feel if consumer confidence levels stay as they are, Starbucks could be in trouble. I have always stated that Starbucks is not a recession proof stock.

We witnessed this in 2008 and 2009 when its earnings went through the floor. Watch  Walmart (NYSE:WMT) and McDonalds (NYSE:MCD) earnings this quarter. They will probably thrive on weaker consumer confidence as they are discount brands. Starbucks isn't, as can be illustrated by the company's move into high end roasteries and cafes. Therefore I believe macro events will affect this stock more than people realize. If in the 4th quarter, we don't see a bounce back in comps growth, then a new downward trend may have definitely started.

The Technicals Do Not Look Strong At Present

The worry that the stock has at present is that it is not cheap. At 34 times earnings, Starbucks is selling well above the industry average of 27 and would certainly fall if traffic numbers continue to disappoint. On a technical chart we can see that there is strong support at the $54 level but if this support was to fail, there is not very much support below until we get to the $40 level. This makes the company's fourth quarter earnings results pretty crucial in my opinion.

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Loyalty Program Saw Sizable Gains

On a positive note, Starbucks has gone through difficult quarters before (in terms of traffic) but has always found a way to adapt. Furthermore, it is leading the sector with its mobile order & pay initiative, and its rewards program is booming. In fact, membership numbers grew by 18% to 12.3 million in the US which is bullish for sales through the mobile app. The new program is spend based which means customers will be incentivised to spend in order to take advantage of the program. The jury is still out on how much these numbers will contribute to growth as major incentives were provided to customers initially to get them to sign up. Time will tell.

The Chinese Market Is A Big Growth Possibility

China with its 7% growth figure definitely was the highlight of the earnings announcement. The pace of store openings is increasing and the chain's new type stores continue to outperform generic units. Starbucks holds potential in this market with the impending roll-out of "Teavana" which has the potential to move the needle here. Although this market is still too small to stem losses from the US, if Teavana can gain some traction, then 7% comps growth may only be the start.

To sum up, Starbucks missed on revenue and comps growth in its latest earnings. There was good news relating to loyalty program membership growth and China, but US growth was down and the stock subsequently sold off. Starbucks is not cheap and I would refrain from entering at these levels until traffic numbers settle down. Furthermore, global macro factors will affect this premium brand stock more than others in my opinion.

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