Fitch Affirms Starbucks' IDRs at 'A-/F2'; Outlook Stable

Fitch Ratings has affirmed the following ratings of Starbucks Corporation (Starbucks; NASDAQ: SBUX):

--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 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 8x gross rent-to-operating EBITDA plus gross rent) in the low 2.0x range within the near-term time horizon. For the latest 12 month (LTM) period ended June 29, 2014, rent-adjusted leverage was 2.1x, relatively flat versus the fiscal year ended Sept. 30, 2012 despite a $1.5 billion increase in debt to partially finance a $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 4.6x and funds from operations (FFO) fixed-charge coverage was 1.6x. Fitch projects that operating EBITDAR-to-gross interest expense plus rent will stay in the mid 4.0x range through 2015 and that FFO fixed charge coverage will approach 4.0x in 2015.

Growing Cash Flow, Balanced Financial Strategy

Starbucks' cash flow from operations (CFO) grew to $2.9 billion in 2013 from $1.3 billion in 2008. Excluding the $2.8 billion one-time payment mentioned above, CFO is up 29% to $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) totaled $1.2 billion or 8% of the firm's $14.9 billion of revenue in 2013, up from $441 million or approximately 4% of revenue as reported in 2010 due to accelerated store growth, remodeling, and equipment upgrades. Dividends have been growing with earnings and in line with the firm's targeted payout ratio of 35% - 45% 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 $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 $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 10% 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 5% 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 11% to $12.3 billion and operating income increased 24% to $2.2 billion. Consolidated operating margin expanded to 18.1% from 16.2% for the same period last year. Results were driven by 6% 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% 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 10 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% to $1.91 per pound in 2014 but then decline slightly to $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% from 55.7% two years prior. Starbucks ranked third behind McDonald's Corp. 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 5% 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 totaled $1.9 billion and consisted of approximately $1 billion of cash, $177 million of short-term investments, and $727 million of availability under the firm's $750 million undrawn revolver after excluding $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 $1.3 billion of the company's $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 totaled $177 million. Long-term investments totaled $833 million and included a combination of corporate debt, government securities, agency obligations, auction rate securities, and mortgage and asset-backed securities.

Starbucks' $750 million revolver, which provides additional liquidity, expires on Feb. 5, 2018. Amounts outstanding under the company's $1 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 $400 million 0.875% notes due December 2016 and $550 million 6.25% notes due August 2017.

RATING SENSITIVITIES

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 2.0x 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-2.0x 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.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 2014);

--'2014 Outlook: U.S. Restaurants - Shareholder Demands to Rise, Even as Market Share Battle and Cost Pressures Continue (Dec. 2, 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

2014 Outlook: U.S. Restaurants (Shareholder Demands to Rise, Even as Market Share Battle and Cost Pressures Continue)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724335

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=873514

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Contacts:

Fitch Ratings
Primary Analyst
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Director
+1-312-368-3195
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
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Senior Director
+1-312-368-3125
or
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