Chicago / IL. (fr) Fitch Ratings has affirmed the following ratings of Starbucks Corporation: Long-term Issuer Default rating (IDR) at «A-»; Bank Credit facility at «A-»; Senior unsecured notes at «A-»; Short-term IDR at «F2»; Commercial paper at «F2». The Rating Outlook is Stable. At June 29, 2014, Starbucks had approximately 2,1 billion USD of total debt, none of which consisted of commercial paper.
Key Rating Drivers
Strong «A-» Credit Profile: Ratings reflect Fitch´s expectation that Starbucks will maintain total adjusted debt-to-operating Ebitdar (Rent-adjusted leverage – defined as total debt plus eight times gross rent-to-operating Ebitda plus gross rent) in the low 2,0 times range within the near-term time horizon. For the latest twelve month (LTM) period ended June 29, 2014, rent-adjusted leverage was 2,1 times, relatively flat versus the fiscal year ended September 30, 2012 despite a plus 1,5 billion increase in debt to partially finance a plus 2,8 billion legal payment related to the firm´s prior distribution agreement with Kraft Foods Global Inc. Operating Ebitdar-to-gross interest expense plus gross rents was 4,6 times and funds from operations (FFO) fixed-charge coverage was 1,6 times. Fitch projects that operating Ebitdar-to-gross interest expense plus rent will stay in the mid 4,0 times range through 2015 and that FFO fixed charge coverage will approach 4,0 times in 2015.
Growing Cash Flow, Balanced Financial Strategy: Starbucks´ cash flow from operations (CFO) grew to plus 2,9 billion in 2013 from plus 1,3 billion in 2008. Excluding the plus 2,8 billion one-time payment mentioned above, CFO is up 29 percent to plus 2,6 billion through the first three quarters of fiscal 2014 due mainly to higher operating earnings. Cash flow priorities include investing in the business and returning cash to shareholders. Capital expenditures (capex) totalled plus 1,2 billion or eight percent of the firm´s plus 14,9 billion of revenue in 2013, up from plus 441 million or approximately four percent of revenue as reported in 2010 due to accelerated store growth, remodelling, and equipment upgrades. Dividends have been growing with earnings and in line with the firm´s targeted payout ratio of 35 to 45 percent of net income which Fitch views as reasonable versus restaurant peers.
Annual free cash flow (FCF – defined as cash flow from operations less capex and dividends) has averaged approximately plus 750 million since 2008. Fitch believes FCF can approximate or exceed the firm´s historical average in most years, although 2014 FCF is being impacted by the firm´s plus 2,8 billion one-time legal payment to Kraft. Starbucks engages in share repurchases to offset dilution from equity compensation plans with additional amounts being opportunistic.
Robust Operating Performance: Starbucks´ record operating performance is being driven by mid-single digit same store sales (SSS) growth, increasing points of distribution as the firm opens new units and expands via the grocery channel, and up until 2014, a favorable coffee cost environment. Fitch views Starbucks´ long-term annual revenue growth target of at least ten percent as achievable, given multiple distribution platforms that are being supported by the firm´s My Starbucks Reward loyalty program, leadership in mobile payment, and continued expansion into food. Global SSS have increased five percent or more for 18 consecutive quarters, due to transaction growth and modest increases in average check. Net new unit development is progressing at a mid-single-digit rate or higher, as discussed above.
During the three quarters ended June 29, 2014, consolidated revenue grew eleven percent to plus 12,3 billion and operating income increased 24 percent to plus 2,2 billion. Consolidated operating margin expanded to 18,1 percent from 16,2 percent for the same period last year. Results were driven by six percent global SSS growth, new units, and lower commodity coffee prices as the firm had locked in most of its needs ahead of the recent run up in prices.
Starbucks indicated that roughly 60 percent of its 2015 coffee needs were locked in at prices relatively flat to 2014 as of July and expects commodity costs to be neutral or have a slightly negative impact on fiscal 2015 results. The company implemented high-single digit price increases on packaged coffee in July of 2014 and increases ranging from ten cents to 20 cents on certain beverages in U.S. cafes in June. As of July 2014, World Bank Group forecast that Arabica coffee prices will increase nearly 40 percent to plus 1,91 per pound in 2014 but then decline slightly to plus 1,77 per pound in 2015. Fitch expects Starbucks´ operating margins to benefit from increasing sales with modest additional expansion in fiscal 2015.
Market Leadership, Strong Brand Equity: With 20’863 units globally at June 29, 2014, Starbucks is a leader in the U.S. restaurant industry and the fast-growing U.S. beverage-snack category. According to Nation´s Restaurant News Annual Top 100 Survey dated June 30, 2014, Starbucks is No. 1 in the U.S. beverage-snack category and has increased its market share to 57,4 percent from 55,7 percent two years prior. Starbucks ranked third behind McDonald´s Corporation and Subway in terms of U.S. system wide foodservice sales and units.
China has become Starbucks´ second largest market outside of North America and SSS in the Europe, Middle East, and Africa (EMEA) region have gained traction, increasing five percent for the three quarters ended June 29, 2014. Fitch believes Starbucks´ well-respected brand, expertise in coffee, additional food, tea and juice offerings, and ability to engage customers with its rewards loyalty program and mobile payment systems will help sustain SSS growth globally in the near term. Moreover, expanding points of distribution via grocery and other retail outlets is additive to sales and also helps strengthen Starbucks´ overall brand equity and customer loyalty.
Liquidity and Debt Structure: Starbucks´ liquidity is supported by its good cash flow generation and ready access to capital markets. At June 29, 2014, liquidity totalled plus 1,9 billion and consisted of approximately plus one billion of cash, plus 177 million of short-term investments, and plus 727 million of availability under the firm´s plus 750 million undrawn revolver after excluding plus 23 million of letters of credit.
Fitch views off shore cash as not readily accessible due to a general reluctance of firm´s to repatriate because of incremental tax cost. Starbucks reported that plus 1,3 billion of the company´s plus 2,0 billion of cash and investments, short-term and long-term, were held in foreign subsidiaries at June 29, 2014. As mentioned above short-term investments totalled plus 177 million. Long-term investments totalled plus 833 million and included a combination of corporate debt, government securities, agency obligations, auction rate securities, and mortgage and asset-backed securities.
Starbucks´ plus 750 million revolver, which provides additional liquidity, expires on February 05, 2018. Amounts outstanding under the company´s plus one billion commercial paper (CP) program are backstopped by available commitments under the revolver. As mentioned previously, there was no CP outstanding at June 29, 2014. Upcoming maturities are manageable with plus 400 million 0,875 percent notes due December 2016 and plus 550 million 6,25 percent notes due August 2017.
Future developments that may, individually or collectively, lead to a positive rating action include: An upgrade of Starbucks´ ratings is not anticipated in the near term. However, total adjusted debt-to-operating Ebitdar below 2,0 times due to cash flow growth and a balanced financial strategy would warrant a positive rating action. An upgrade would be predicated on SSS trends remaining consistently above industry peers, stable or improving margins, and successful expansion into beverages other than coffee and food as well as the lunch and dinner day part. Fitch views increased diversification within food positively given increasing competition within the beverage category.
Future developments that may, individually or collectively, lead to a negative rating action include: Rent-adjusted leverage sustained above the mid-2,0 times range due to substantially higher debt, particularly if management becomes more aggressive with share repurchases, and a weakening of operating trends would trigger a downgrade. SSS declines, margin contraction, and materially lower FCF would be viewed negatively.