Rumors of Starbucks' Decline Have Been Greatly Exaggerated

Rumors of Starbucks' Decline Have Been Greatly Exaggerated

On Tuesday, news broke that ITG Investment Research, an equity-research firm and subsidiary of Investment Technology Group based out of New York, expects Starbucks to see slower growth moving forward. Following the announcement, shares of the world's largest coffee chain fell more than 3%. In light of this news, is now the time to sell the chain or is the market overreacting to ITG's findings?

A look back at Starbucks
Over the past few years, Starbucks has grown tremendously. Between 2009 and 2013, the company's revenue rose by 52.4% from $9.77 billion to $14.89 billion. This growth has been primarily attributed to a 123.8% jump in Starbucks' number of locations, from 8,832 at the end of 2009 to 19,767 in 2013.

As Starbucks increased its store count and its comparable-store sales grew over this time-frame, its net income rose by 254.1% from $390.8 million to $1.38 billion in 2012. Due to the unfavorable outcome of a lawsuit by Kraft alleging that Starbucks breached an agreement between the companies, Starbucks took a pre-tax charge of $2.78 billion in 2013. However, if you remove the litigation charge from Starbucks' financial statements and adjust for its tax implications, the company's net income would have grown a further 14.5% to $1.58 billion in 2013.

Though management reported an increase in the number of locations (franchised and company-owned combined) of 9.4%, Starbucks also saw comparable-store sales jump roughly 7%. Of the comparable-store sales growth, 5% came from higher traffic while another 2% came about from higher prices, so it should be concluded that the growth was healthy.

ITG's expectations
To be clear, ITG doesn't expect Starbucks to fall off the map or anything of the sort for the current quarter. In fact, the company actually believes that Starbucks will still manage to grow its comparable-store sales by 5%-6% within the United States. This would be only slightly less than the 7% rate the company saw in the U.S. throughout 2013.

In comparison, rival Dunkin' Brands Group saw only a 4.2% increase in comparable-store sales in the U.S. as of its most recent fiscal year. Year-to-date, the chain has done even worse with comparable-store sales rising 3.3% in the U.S. and sales contracting internationally. If ITG is correct about Starbucks, this could also signal a further decline in growth for Dunkin'.

However, the Foolish investor shouldn't fear that this is the end of Starbucks, Dunkin', or anyone else in the coffee industry. J.M. Smucker , who acts as the distributor of packaged coffee products for Dunkin', reported that its coffee sales declined by 6% in its most recent quarter. The decline was driven by the pass-through of lower commodity prices and it was partially offset by an increase in volume.

On top of higher volume, Smucker saw its operating margin in its U.S. retail coffee segment rise from 25.4% to 30.3%. What this likely means is that, despite sales falling, some margin improvement should be seen by companies like Dunkin' and Starbucks should this trend persist.

Foolish takeaway
Based on the analysis provided by ITG as well as the most recent quarterly results from Smucker, it appears that Starbucks' comparable-store sales will still likely rise but possibly not at the rate that investors have seen in the past. Though this may scare some investors, any decrease in sales growth for coffee sellers should be accompanied by a decrease in cost of goods sold relative to sales.

The downside is that Starbucks' top-line growth could be impaired but its margins should see some improvement as a result. So, to counter the concerns of pessimists, it should be said that ITG may be right and Starbucks may not be as high-flying in the future as some might have hoped. However, margin improvement should set Starbucks up for better and more sustainable long-term growth down the line.

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Originally published