If you're a current Starbucks' (NASDAQ:SBUX) shareholder, you may be wondering why the market isn't seconding your convictions. The company's stock hasn't just under-performed the S&P by 10% year-to-date, it's essentially flat, down nearly 1%. Over the last 12 months, Starbucks has declined 2% on a total-return basis, versus the S&P 500's total return of nearly 18%.
And yet by a host of operational metrics, the company continues to outperform larger and smaller peers. During Starbuck's fiscal 4th quarter 2014 earnings call on Oct. 30, management highlighted several themes driving the company's success. Below are significant insights that CEO Howard Schultz, COO Troy Alstead, and CFO Scott Maw pointed out during the company's earnings call.
Judge us alongside our competition
"When I look at the results of this year, the stunning accomplishments on so many levels, I hear somebody is disappointed with a 5% comp on a base of over 7,500 stores. I just got to ask myself, is there a company in your universe putting up these kinds of numbers? And the answer is no." -- Howard Schultz
In departing from his scripted opening remarks, CEO Howard Schultz displayed disbelief that the anyone on Wall Street could be disappointed with Starbucks' results. Objectively, Schultz has a point: the company set either a revenue, net income, or earnings per share record (and sometimes all three) in each quarter of the fiscal year just concluded.
But within the opportunity lies a conundrum: There is no other pure retail coffee competitor anywhere near the size of Starbucks to which it can be compared. The company competes with quick service restaurants like McDonald's (NYSE:MCD) at breakfast, fast-casual restaurants such as Panera Bread (NASDAQ:PNRA.DL) at lunch, and local coffee chains and independent coffee houses during other dayparts.
Thus, the only adequate benchmark appears to be Starbucks itself. Investors have treated the stock cautiously over the last year, continuously anticipating a stall in its enviable numbers. While a comparable store sales increase of 5% during the quarter is impressive, this was the 19th consecutive quarter of "comp" increases of 5% or greater, and the market seems to be waiting for the other coffee cup to drop.
"CAP" is still a huge growth driver
"...our new stores in China are exceeding the year one pro forma sales we projected. These results and investments we made across the region, including pending acquisition of Starbucks Japan, gives us great confidence and optimism about our future performance in the CAP segment." -- Troy Alstead
For many multinationals who use it, the acronym "CAP," or "China Asia Pacific" has lost some of its luster in 2014. In China, a prickly regulatory environment spurred by a government which seems almost resentful of the foreign investment it invites, has caused western companies to second guess expansion plans. In addition, a slowing Chinese economy has dampened consumer spending.
Yet for Starbucks, which first hung out its shingle in China in 1999, business continues to flourish. During the earnings call, CEO Schultz revealed an amazing statistic on Starbuck's China expansion: The company is presently opening an average of one store a day in China, at "a pace that will only accelerate for years to come."
We're ahead of the trend away from brick and mortar retail
"If you remember last year, I spoke very specifically about the seismic change in consumer behaviors. And what I talked about specifically was a downturn in the kind of traffic that we saw historically, that I felt strongly was being displaced by e-commerce and mobile shopping." -- Howard Schultz
In the quote above, Schultz referred to the phenomenon of decreasing traffic in retail locations, both during the holidays and beyond, as consumers increasingly utilize online shopping. This trend has been accompanied by a shift in gift-giving preferences, away from physical goods and toward gift cards and monetary transfers.
Management indirectly blamed the pressure on retail visits for a middling traffic increase in the Americas segment of just 1% during the quarter, one of the very few components of the report that could be deemed less than stellar. To combat this trend, and benefit from the evolving popularity of gift cards, the company announced a 2014 holiday promotion during the call, centered around its popular prepaid cards.
Starbucks patrons will be able to choose from a collection of 100 new uniquely designed cards, and in a page borrowed from McDonald's popular "Monopoly" game, 500,000 food and beverage prizes will be given away to "My Starbucks" card and app users, along with 13 grand prizes of "Starbucks for Life."
Last year during fiscal Q1 (which includes the holiday months of October, November, and December), Starbucks saw 1.4 billion loads of its prepaid cards. Investors will eagerly await the next quarterly report for what will likely be an improvement on this number.
In financial terms, these prepaid transactions represented a massive $1.5 billion in accrued liability on Starbucks' Oct. 30 balance sheet. That's $1.5 billion in cash already collected by the company, which will be recognized as earnings in future periods, as customers swipe their cards for coffee, other beverages, and food items.
"Mobile order and pay" will super-charge our business
"...No company in any industry offers any technology remotely like Starbucks' Mobile Order and Pay, plus we get the added benefit of increased store throughput and speed of service for all our customers." -- Howard Schultz
In December, Starbucks will introduce its "mobile order and pay" service in Portland. This innovation will allow customers to place and pay for an order before reaching a Starbucks location, via the company's mobile phone app. The service will be rolled out nationwide in 2015. While Starbucks' promotional activity will probably focus on the in-store experience, the company's greatest gain may be related to drive-through traffic.
Drive-through stores were once avoided by management as they were thought to degrade the quality of the Starbucks' brand. But as COO Troy Alstead noted on the call, drive-through locations now comprise 42% of U.S. stores, and accounted for 50% of company operated store sales, as well as 55% of company operated store profits, during the quarter. If the company has done its logistics homework, mobile order and pay will positively impact throughput times at Starbucks windows, particularly during the busy morning and lunch periods. We should have feedback from management on the initial roll-out early next year.
Operating margin expansion is on a tear
"One of the most significant financial items to highlight is the 280 basis point increase in non-GAAP operating margin reflecting our ongoing ability to leverage operating cost and control cost of goods sold. This is the highest level of non-GAAP operating margin expansion we have driven in almost four years." -- Scott Maw
The growth of revenue and store counts has been such a focus point for Starbucks investors, that the company's ability to control costs, obtain sales leverage, and manage volatile coffee commodity pricing, is often overlooked. The company's 2.8% increase in non-GAAP operating margin during the quarter is evidence of Starbucks' disciplined approach to running its business.
I personally favor looking at GAAP operating margin, that is, the operating margin when financial statements are presented in accordance to "Generally Accepted Accounting Principles." It's too easy for corporations to pick and choose items they want to exclude from calculations when a "non-GAAP" number is presented.
However, in this case, the non-GAAP comparison is appropriate, as investors should remove the effects of last year's $2.8 billion litigation settlement with Kraft Foods Group to see an apples-to-apples comparison. And management's point is well-taken: despite its formidable growth, Starbucks still manages the bottom half of its income statement with discipline and vigor. Perhaps in 2015, we'll see this and other areas of Starbucks' execution reflected in the stock price.
Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends McDonald's, Panera Bread, and Starbucks. The Motley Fool owns shares of Panera Bread and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.