Something’s brewing over at Starbucks Corporation (NASDAQ:SBUX) and it’s not very enticing. After seven consecutive years of positive shareholder growth, Starbucks stock is staring at a loss for 2016. Since January’s opener, SBUX is down over 9%, but it’s not just the volatility that’s concerning.
Between 2009 and 2015, returns for SBUX stock averaged 48%. Clearly, the risk appetite for investors has faded. Can the business and pop-culture icon turn things around?
Quite frankly, you never want to dismiss Starbucks stock.
The coffeehouse chain’s phenomenal success and market share dominance ensures its stability through good times and bad. But no company is invincible.
A recent surge in coffee prices has put a damper on the entire industry. Ordinarily, coffee producers can hedge their exposure to commodity swings through shrewd trades in the futures market. However, SBUX and prime competitors Yum! Brands, Inc. (NYSE:YUM) and McDonald’s Corporation (NYSE:MCD) may be facing a uniquely bad situation.
Tough Headwinds for Starbucks Stock
First, a prolonged drought in Brazil has parched many agricultural lands to the point that the government doesn’t want to risk waste by irrigating them. Obviously, that only exacerbates problems for Brazilian coffee farmers, who contribute a significant portion of the world’s robusta beans. Robusta is commonly used in espresso drinks and instant coffee products. With Brazil’s harvest expected to decline by 16% this year, that’s a huge affect on the supply chain.
More worrisome for Starbucks stock is the price of arabica beans. This is the key ingredient found in all premium coffee products, and the only one used by SBUX. Arabica’s average market price has risen 18% from January to the end of July, and there’s no sign of it slowing down. So while arabica beans could be used to ameliorate the robusta squeeze, the substitution won’t be cheap. Also, the increased aggregate demand would pressure margins for SBUX stock.
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In its earlier years, coffee prices did not have a statistically significant impact on company shares. But since the beginning of this decade, Starbucks stock and the price of arabica beans have a strong, inverse correlation. In other words, an argument could be made that SBUX stock has benefited from a lesser burden in overhead costs. But now, that “free ride” appears to be coming to an end.
SBUX Will Test the Markets
How the SBUX management team will respond to these developments will say a lot about its nearer-term trajectory. For example, profit margins for Starbucks stock are at the upper range of the spectrum for the broader restaurant industry. In order to keep its impressive earnings growth alive, SBUX has to protect its margins. That’ll keep shareholders happy, but it also means passing on the costs to consumers.
According to a study conducted by the U.S. Department of Agriculture, there is a one-to-five ratio impact in the retail coffee price versus the commodity market price. Thus, if the market were to jump 10 cents, consumers on average would pay an additional 2 cents for their coffee. It’s a lever that the company pulls quite frequently, and Starbucks stock has yet to suffer from it.
To no one’s surprise, SBUX has again raised prices this year for a good chunk of its beverage lineup. But with the coffee markets acting the way they are, these hikes may increase in frequency and intensity. One wonders, though, how the customer will react. The economy isn’t as great as we’re often told by politicians. The latest read on consumer sentiment is mixed, reflecting the middling performance of the labor market.
The Flipside of SBUX Stock
Despite the negative news cycle, this isn’t an invitation to short SBUX stock. The java giant’s efforts to branch into new sectors serve it well.
In particular, Starbuck’s “Teavana” brand is an opportunity to capitalize on the tea-crazy Asian market, where the company operates more than 6,000 stores. And in terms of its core coffee product, U.S. stockpiles of both arabica and robusta should theoretically keep costs from jumping too high.
Also, we have to remember that Starbucks stock is a proven winner. Since 1992, investors have suffered only five years of negative returns. This year will probably make it six, but those are still incredibly good odds for SBUX stock. Significantly, the coffeehouse has only had one set of back-to-back losses, in 2007 and 2008. Based on this history, there’s a very good chance that Starbucks stock will make a comeback in 2017.
But for now, be careful. The bullish argument has yet to convince SBUX stock to reverse a downward trend channel that originated in November of last year. The competition doesn’t look too hot either. There’s still a lot of chop that needs to be worked out, and fundamental headwinds aren’t helping. But once the skies clear, Starbucks stock should represent solid value.
As of this writing, Josh Enomoto did not hold a position in any of the aforementioned securities.
