Starbucks Maintains Dividend, Expects Full Recovery Over Time

On April 8, Starbucks (SBUX) provided a business update in response to the coronavirus pandemic. 

The company's board of directors recently approved Starbucks' next dividend, which will be paid in May, and management confirmed that they do not anticipate reducing the dividend going forward despite temporary store closures:

Management's confidence in the dividend stems from the belief that business will likely return to normal within several quarters.

In China, which accounts for around 10-15% of sales and was hit by COVID-19 first, Starbucks' comparable store sales hit a weekly low of -90% in mid-February. 

By the last week of March, comparable store sales declined by 42%, representing the seventh consecutive week of sequential improvement.

Over 95% of Starbucks' stores are now open in China, though many are operating with reduced hours and limited seating in compliance with local guidelines. 

Management is optimistic that its business in China will "fully recover over the next two quarters."

The Americas (U.S., Canada, Latin America) account for about 70% of the company's revenue. 

Quarter-to-date through March 11, U.S. comparable store sales growth of 8% was the strongest pace the company had delivered in four years.

But beginning on March 21, Starbucks restricted most of its operations to drive-thru and delivery channels. 

During the last week of March, comparable store sales were down 60% to 70%, with 44% of Starbucks' company-operated locations open (with reduced hours, primarily through the drive-thru channel). 

While Starbucks withdrew its guidance for the year, management expects the negative financial impacts to the fiscal third quarter (ending in June) to be "significantly greater" than they were last quarter and to extend into the fourth quarter (ending in September). 

Management will provide more information following Starbucks' earnings report on April 28, but a full recovery is expected eventually: 

With the company continuing to generate some sales during the pandemic, plus its solid balance sheet, Starbucks has the ability to continue supporting its dividend during these lean times.

At the end of March, Starbucks had $2.5 billion of cash on its balance sheet, plus an additional $3.5 billion available through its borrowing facilities.

After reviewing the bonds Starbucks issued in mid-March, we don't believe the firm has any long-term debt due until February 2023.

Starbucks' dividend costs about $2 billion annually, and its store operating expenses and general and administrative costs totaled around $13 billion last fiscal year. Besides payroll, these expense categories contain a lot of fixed costs that cut into earnings quickly when revenue drops.

If Starbucks' revenue fell 70% this quarter, 50% next quarter, and 10% in the quarter after that before returning to normal, we estimate that the firm's annual gross profit (money available before paying operating expenses) could fall from $18 billion to around $12 billion.

That seems like a conservative scenario, and it would only result in a shortfall of several billion dollars annually to cover the dividend and last year's full operating expenses. Starbucks could, in theory, cover this deficit for at least a year or two with its current liquidity.

Starbucks should be able to reduce its operating expenses with so many of its stores closed as well, so there may not be much of a cash flow shortfall, especially if its pace of new store development slows.

Leverage will rise temporarily as earnings dip. Management expects the impacts of COVID-19 to cause Starbucks' leverage ratio to exceed its max target of 3x rent-adjusted EBITDA.

However, since the company views these impacts to be temporary, leverage is expected to return to normal levels in the future and preserve Starbucks' BBB credit rating.

Overall, the severity and duration of this crisis will determine how quickly Starbucks' business recovers.

Some consumers could be slow to return once the pandemic subsides, but the company's liquidity and operational flexibility (drive-thru, delivery, digital ordering) position it well to get to the other side, especially compared to smaller coffee shops.

And in the long term, Starbucks' brand value and expansion opportunities are arguably unchanged despite today's challenging environment. We will continue monitoring the situation.