Starbucks Is Now a Turnaround Story -- Here's How Management Did It

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Starbucks' (SBUX) - Get Report third quarter earnings are just another flag in the hat of a company that has branded itself to investors as the rejuvenated growth engine that could. 

When earnings rolled in Thursday afternoon, the once-dead coffee chain boasted sales growth rates and an earnings number that proved to investors the last few quarters of excellence is not a fluke, but rather a trend for the future.

Earnings per share was an adjusted 78 cents, beating analysts estimates of 72 cents. Moreover, U.S. same-store-sales growth was 7% year-over-year, with the ever-important growth region of China seeing the metric come in at 6%. Those growth rates had been stuck at around -1% to 1% in the summer of 2018, with earnings growth anemic. Digital memberships for the third quarter 2019 grew 14%, another encouraging growth rate. Many market participants are looking for a 15% earnings growth rate for the next several years. 

The stock was rising 8.72% to $98.90 a share Friday. The stock is now up 90% in the past year. 

It was an "absolutely stunning quarter," Jim Tierney, chief investment officer of concentrated U.S. growth at Alliance Bernstein told TheStreet. The Alliance growth fund holds Starbucks. "We were pleased with third quarter's top and bottom-line beat," Andrew Charles, analyst at Cowen wrote in a note, in which he moved his Starbucks price target up to $93 from $77. 

It's been management's ability to be attuned to both customers and employees that has driven strong foot traffic, higher loyalty and membership digital membership growth rates and store efficiencies. 

Foot Traffic

Foot traffic grew at 3% for the quarter. "The knock on the company had been that you're raising prices but you're not getting traffic, and that had been the big concern," Tierney said. The foot traffic in the quarter was "absolutely phenomenal." Tierney is optimistic that the higher foot traffic is one important factor bringing the stock's multiple higher. "The 2017 and 2018 [low traffic growth] will be seen as the abnormality rather than the new normal," Tierney said. Charles moved his 2020 earnings target multiple to 30 from 25. 

Management noted that the higher foot traffic resulted from a few factors. Firstly, store employees no longer clean stores during hours. They now clean after hours. This enables more sales and better customer service. These higher sales come without an increase in marketing spend or other expenses, incrementally lifting Starbucks' operating margin to 22%. Starbucks currently trades at 30 times forward one-year earnings. 

Another foot traffic driver? There are now happy hours in the afternoon, which management said drove solid afternoon sales. 

Loyalty and Digital Members

The strong growth of rewards members was partly driven by knowledge of customers. "We know a lot more about our customers now," Chief Operating Officer Roz Brewer said on the earnings call. Plus, "The comps have been in the low single digits, so if you're increasing your most loyal members at a low to mid teens rate that's great because ultimately they'll turn into repeat customers," Tierney said. 

TheStreet's Jim Cramer has his ear to the ground on exactly what management's thinking is. He knows CEO Kevin Johnson, and explained he isn't the least bit surprised that Johnson has been able to lead such an impressive turnaround. 

Risk Reward Scenario 

Of course, getting into the stock now may pose some risk, as the earnings multiple may be somewhat rich. Tierney said it's hard to say whether the expected earnings annual growth rate for the next few years of 15% is fully pried in, but that it's possible it's not fully baked in to the stock. He said if Starbucks maintains that rate, the stock could move up 15% per year for the next couple of years. 

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