Starbucks disappoints in quarter but recovery in 2018 is on track

Blame it on Christmas Tree Frappuccino.

On Thursday, January 25, after the market close Starbucks (SBUXWealth Strength IndexSBUX is Moderately Up and trending Up) reported December (fiscal 2018 first quarter) earnings of 58 cents a share (excluding one-time tax benefits.) The results were ugly on the revenue side where  the company missed analyst estimates and reported that same store sales grew by just 2% instead the 3% estimate. That marketed the eighth straight quarterly miss on comparable sales. Operating margin was 19.2% for the quarter, a decline of 80 basis points year over year.

Starbucks shares closed 4.23% lower. (Starbucks is a member of my Jubak Picks Portfolio. The shares were up 0.62% as of Friday’s close since I added them to this portfolio on January 2, 2018.) )

The company identified two problems in the quarter.

First, in general, while growth in China was good with 6% comparable store sales growth and a 30% increase in revenue, sales in the U.S. continued to lag.

Second, more specifically, the problems with U.S. sales growth only gradually emerged as the quarter moved along. Through the first half of the quarter, U.S. comps were up 3%, but the quarter slowed as it went along with comparable sales growth slowing to just 1%. For the entire period comparable sales climbed just 2%. The company’s limited-time holiday beverages, such as Christmas Tree Frappuccino, Peppermint Mocha, and Gingerbread Latte, underperformed expectations. In addition, like the rest of the retail sector, Starbucks is getting hit by the decline in traffic at U.S. malls with comparable store sales at mall locations coming in several percentage points below sales growth at non-mall locations. Mall locations make up about 6% of U.S. stores.

The initiatives that the company has already announced–stepping up food offerings at breakfast and lunch, the high-end Roastery experience, and the roll out of a second sweeter Blonde Espresso roast and its Nitro Cold Brew (going to 2,300 stores by the end of 2018 from 1,300 stores now)–continue to look promising to me as fixes to slow U.S. growth as well as to continued sales growth in China where the Shanghai Roastery performed above expectations.

For fiscal 2018 the company raised its earnings per share forecast above Wall Street projections and affirmed its earlier guidance for same store sales growth of 3.5%.

I’d certainly rather have bought these shares after this disappointment rather than before, but I think a turnabout in comparable sales and continued growth in China remains on track for 2018. I’m keeping my target price at $68 a share.