While broad market indices have soared over the past few years, Starbucks Corporation (NASDAQ:SBUX) has stalled out. SBUX stock is basically flat over the past two years and, in fact, is trading 15% below its all-time high of near $65 reached back in early June.
There are some good reasons why SBUX stock hasn’t performed that well of late. Third quarter earnings, released in July, were a mixed bag, but investors focused on the negatives, including guidance for lower-than-expected same-restaurant sales growth and earnings.
The earnings report highlights the “good news/bad news” dynamic facing Starbucks. It certainly isn’t a dying company, by any means. Growth is strong, even if it is decelerating. The company has a major opportunity in China, with a $1.3 billion buyout of joint venture partners in that country boosting earnings in 2018 and beyond.
At the same time, however, there are real pressures here. Wage inflation could hurt Starbucks, as the company has to spend more to keep employees amid minimum wage raises and higher wages elsewhere in retail and food service. The key US market looks increasingly saturated. Growth in Europe has stalled out.
Those issues don’t necessarily mean Starbucks’ growth is coming to a quick end — or that SBUX stock is a good short candidate. But with SBUX stock still trading at a pricey 27 times 2017 EPS guidance, steady growth is baked into the valuation here. And I’m skeptical Starbucks can do much more than that.
The Concerns Facing SBUX Stock
To be sure, Starbucks remains a great company. And with SBUX stock near its lowest levels of the year, and hovering around support that generally has held in the $52-$54 range, there is a long-term bull case to be made for the stock.
At the same time, however, there are some nagging concerns. For one, wage inflation could pressure margins. Minimum wage hikes, including a hike to $15 an hour in Starbucks’ home market of Seattle, could increase labor costs. But other companies in and around Starbucks’ space are quickly raising wages themselves.
Target Corporation (NYSE:TGT) is moving to a $15 company-wide minimum by the end of the decade. McDonald’s Corporation (NYSE:MCD), which competes with Starbucks in the coffee market, already has increased pay rates and benefits. Wal-Mart Stores Inc (NYSE:WMT), TJX Companies Inc (NYSE:TJX) and other large employers similarly have raised wages recently.
At the same time, sales growth is decelerating. Starbucks long has posted amazing growth rates, with domestic comparable-restaurant sales rising 6-8% every year since the recession. But global comp growth is expected to slow to 3-4% this year — not much more than needed to leverage those rising costs.
The combination implies that the days of 15%+ EPS growth may be over. With competition intensifying everywhere — from McDonald’s to the myriad independent roasters in nearly every city — that deceleration may be permanent. And the argument from SBUX bears is that even a 27 EPS multiple is too dear for that type of future.
Bull Case for Starbucks
All hope isn’t lost, however. Starbucks is making a big bet on Asia, in particular. In late 2014, the company acquired the 60.5% of Starbucks Japan held by its joint venture partner. It did the same in East China in July, paying $1.3 billion to buy out its partner in that market, and bringing 1,300 stores under its complete control in the process.
Over a quarter of Starbucks stores now are in what the company calls the China/Asia Pacific segment. And while that region had a disappointing FY16 (same-restaurant sales growth of 3%), it has historically been a strong market for the company, with same-restaurant sales rising a total of 46% in the preceding four years. As the Chinese economy, in particular, matures, Starbucks should have room for location growth it may no longer have in the US, in particular.
Meanwhile, even if Starbucks’ EPS growth slows down, it still has levers to pull to drive value. Bear in mind that the torrid gains in McDonald’s stock have been due, in large part, to optimism regarding the company’s refranchising efforts. McDonald’s same-restaurant sales have improved as well, but it has benefited from easy comparisons to stagnant growth.
By any long-term measure, Starbucks’ growth has well outpaced that of McDonald’s. And, yet, McDonald’s stock trades at nearly 25 times 2017 EPS estimates, only a modest discount to SBUX stock. Starbucks, in theory, should have the same opportunity to change its licensed/operated mix, as it’s already done in Japan, China and (to a much smaller extent) Germany. It’s hard to argue that SBUX stock should be valued similarly to MCD stock, given its growth advantages and its room for improvement. On that basis, Starbucks stock looks downright cheap.
The Right Entry Point for SBUX Stock
The problem is that MCD stock looks downright expensive, at this point — meaning SBUX stock may only be cheap by comparison. And it’s risky to argue against the current narrative surrounding SBUX stock or take the risk of the stock finally breaking support in the low $50s.
There is a price where SBUX stock looks like a buy, but we’re not there yet. 27x EPS is a premium multiple — but Starbucks no longer is providing premium growth.
Without a lower price — something in the mid- to high-40s looks about right — or an acceleration in that growth, investors can’t expect much more from SBUX stock than what it’s provided the last two years.
As of this writing, Vince Martin has no positions in any securities mentioned.
