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3 Big Questions Starbucks' Earnings Helped Answer

By Jason Hall – Apr 26, 2019 at 5:01PM

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The issues: comp-store traffic, fighting off competition in China, and growing income faster than sales.

Starbucks (SBUX -0.08%) reported its fiscal second-quarter results on Thursday, April 25, after market close, and once again demonstrated how it could take a modest sales increase and leverage its scale to deliver solid operating income growth. Moreover, the company continued to prove that there's still room for expansion, adding 319 net new stores in the quarter to finish with more than 30,000 Starbucks stores globally. 

Moreover, the company's results in China helped answer some questions about its ability to perform under increasing competitive pressure, as well as whether efforts to streamline operations in its U.S. stores would pay off with improved results. In both cases, the quarter offered reason to remain optimistic. 

Customer at a table with Starbucks cup in hand.

Image source: Starbucks.

Let's look at Starbucks' earnings report, particularly regarding its efforts in China, the U.S., and its overall strategy to drive higher profits with operating leverage across the globe. 

Starbucks Q2 results: The raw numbers

Here are some important metrics to understand how Starbucks is performing:

Metric Q2 2019 Q2 2018 Year-over-Year Growth
Revenue $6.30 billion $6.03 billion 4.5%
Net income $663 million $660 million 0.5%
Earnings per share $0.53 $0.47 12.8%
Adjusted EPS $0.60 $0.53 13.2%
Operating income $847.7 million $772.5 million 9.7%
Operating margin 13.6% 12.8% 6.3%
Comps growth  3% 2% 100 basis points

Source: Starbucks. 

One thing that may stand out sharply on the table above is that Starbucks' net income only increased a few million dollars from last year, about 0.5%, while earnings per share increased almost 13%. The big disparity here is a result of the company's massive share repurchases over the past year, reducing shares outstanding by nearly 12% since the beginning of 2018. 

Yes, the per-share earnings -- key to shareholder value -- were up substantially, but why didn't the company increase its total earnings very much? In short, it continues to do some restructuring of its operating strategy, which has included selling off certain assets and acquiring others. These activities have added more complexity to the income statement.

For instance, in the 2018 quarter, the company recognized $47.6 million in gains from an acquisition and $35.5 million in interest and other income, while recognizing $21 million and $15 million, respectively, in those categories this year. These two items, unrelated to the company's operations, contributed $47 million more to last year's GAAP net income than this year's. 

These sorts of nonrecurring, noncore sources of income (and expenses at times) are a key reason adjusted income and operating income can be valuable metrics: They can help normalize nonoperating and nonrecurring items to measure the core business' results. The caveat is that they shouldn't replace net income entirely, but augment it as a measure of performance. 

With that long-winded caveat out of the way, the key takeaway is that, when we look beyond GAAP net income, it becomes a little more clear that Starbucks' operations delivered better results. Operating income was up almost 10% on 4.5% revenue growth; operating margin improved 6.3% to 13.6%; and adjusted earnings per share -- gaining the benefit of share buybacks and factoring out some of the nonrecurring items -- increased a solid 13.2%. 

Traffic still isn't growing, but it's holding steady 

Starbucks once again delivered a reasonably decent comps result, with same-store sales at company-owned stores increasing 3%. That's a bit down from the first-quarter result of 4% growth, but was ahead of last year's 2% comps growth. 

When we dig a little deeper, there are a few things that investors should continue to monitor. First, traffic continues to remain relatively flat; according to the comps breakdown, transactions continue to remain unchanged, with higher ticket totals as the source of comps growth. Higher tickets are a result of higher prices, as well as increased attachment of food and other items. 

The good news is, management isn't standing pat. It recently announced changes to its Starbucks Rewards program, making it easier to use rewards in a more customized way. It is also opening up the Starbucks Mobile Order & Pay to non-Rewards customers, to help improve throughput in its stores during peak periods, as well as remove friction for customers of all types, not just Rewards customers.

Moreover, Starbucks' results in China continue to hold up relatively well, with 2% comps growth this quarter. This is particularly important as its existing store base faces pressure from new Starbucks locations -- the company expects to open 600 stores per year there -- and from competitors, which are expanding even faster. 

Looking ahead: upbeat on 2019 and beyond

Starbucks held firm on certain parts of its 2019 outlook as previously announced, while raising the bar on other items. Among the raised expectations, the most notable was for increased operating margin in the Americas segment this year; this follows prior expectations that ongoing efficiency improvements would cost more money this year. 

Moreover, those operating improvements in its biggest segment, along with expectations that its tax rate will be slightly lower, led the company to raise guidance for earnings to a range of $2.40 to $2.44 on a GAAP basis and $2.75 to $2.79 on a non-GAAP basis. That was up from the ranges of $2.32 to $2.37, and $2.38 to $2.73, respectively. 

Management continues to expect sales to grow in a range of 5% to 7%, comps to grow 3% to 4%, and to open 2,100 new stores in 2019. 

Put it all together, and Starbucks continues to get traction with many of its initiatives to improve operations and increase sales, while holding steady on traffic in the face of increased competition in its biggest markets. 

Jason Hall owns shares of Starbucks. The Motley Fool owns shares of and recommends Starbucks. The Motley Fool has a disclosure policy.

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