Starbucks (SBUX) just doesn't make a compelling case for its stock. My big question for Starbucks' fiscal Q1'19 results was whether or not the company could improve its margins. Operating income has been largely sacrificed in order to create sales growth over the past 12 months and it's a trend I don't see working over the long haul. The king of coffee failed to alleviate my concerns. Fiscal first quarter results included solid revenue growth, but margins slipped again. Even worse, earnings took a big 61% fall year over year. Until the company can find a way to drive growth without taking on unreasonable costs, I think the situation will continue to deteriorate.
Revenues increased 9.2% year-over-year to $6.63 billion. The problem here is that operating expenses increased a larger 12.6%, diminishing the gains that should have been associated with higher overall sales. Cost of sales increased 10.3%. Store operations expenses increased 14.7%. The company also incurred $43.2 million in further restructuring. These expenses led to operating income of $1.015 billion; a 9% decline year-over-year. This year's income looks particularly weak relative to last year's because there were no gains from the acquisition of its Asian joint venture, and no gains form divestitures. In all, earnings before income taxes declined nearly 70% to $965.5 million. Net income declined 66.2% to $760.4 million. Diluted earnings per share were $0.61. were it not for the continued decrease in shares outstanding, that figure would have been worse.
Granted it's tough to compare earnings year-over-year when there were non-operating gains from acquisitions and divestitures. Nevertheless, these fiscal first quarter results do not assuage my fears about operating income. The coffee juggernaut continues to drive sales growth, but it is being derived through ever increasing costs. In fiscal 2018, SBUX had revenue gains of 10.4% to $24.7 billion. That's certainly nothing to sneeze at. When you look at the costs incurred in that growth, you realize the company actually has less to work with as its revenue stream grows. A 13.4% increase in total operating expenses led to a 6.1% reduction in operating income year over year in fiscal 2018. The trend was not stopped in fiscal first quarter 2019. How long will Starbucks get away with squeezing its margins in pursuit of deriving higher sales figures?
Up until now, the billions being spent in share buybacks has softened the blow. Margins of 15.3% vs. 18.4% a year ago are just not going to cut it. I correctly predicted awhile ago that this method of sales growth would eat into earnings at some point. The company did the same thing in the Q4'18. Sales increased 10.6% year over year, but operating income fell 6.4%. Earnings also fell 4.1%. They stemmed the bad news a bit by using share buybacks to drive up earnings per share by 3.7% despite the weaker net income.
It's a tactic that might make things look better, but down the road it will result in a lot of debt. Starbucks isn't actually making enough money to finance these stock buybacks. The last few years have not been kind to the company's balance sheet -- largely as a direct result of allocating money to share buybacks.
Perhaps more bothersome than the margins is the way the sales read. If you look closely, you'll see that their largest market, the Americas, actually had 0% growth in actual transactions. The sales growth stemmed from a 4% increase in ticket (the amount being paid for each transaction). Transactions only grew 1% in the Asian market, which is supposedly their growth market. Once again sales relied on a 2% increase in ticket. The EMEA segment actually suffered a transaction decline of 1% with a 0% increase in ticket. I won't see much about their first quarter channel development revenue, which is down 20% after licensing their business to Nestle.
The market might be happy to hear that Starbucks beat estimates for the first quarter, but I think these underlying issues warrant some addressing. I certainly don't think it's a stock primed for large scale growth in the near future. Guidance suggests I'm not far off, as the company expects fiscal year earnings to be $2.32-$2.37 on a GAAP basis. That's much lower than 2018's $3.24. It also has the stock currently trading at almost 30x forward earnings. That's a bit expensive for a stock with declining margins. I have to go against the current here and say Starbucks is a "hold" at best.