We all enjoy a cup of coffee from Starbucks Corporation (NASDAQ:SBUX), but there really isn’t that much to love about the stock. Just take a look at a chart for SBUX stock.
Two years ago, SBUX stock was trading around $60 per share. Today, it trades around $54 per share.
To put that lack of movement in context, the S&P 500 was trading around 2,050 two years ago. Today, the S&P 500 is at 2,570.
In other words, while the market has roared 25% higher over the past two years to trade at all-time highs, SBUX stock has fallen 10% and is just stuck in a trading range between $52 and $65.
What gives? A full valuation that doesn’t appropriately reflect slowing growth for the once high-growth coffee chain.
Consequently, I think SBUX stock is overvalued here. At best, this stock trades sideways over the next 12 months.
The Starbucks Growth Story Is Slowing Down
The proof of slower growth is in the numbers for Starbucks.
Between 2011 and 2016, Starbucks experienced tremendous and stable growth. Not once in that time frame did SBUX report comparable sales growth below 5% or anything but positive transaction growth. That combination of 5%-plus comps and positive traffic trends indicated that consumers love for Starbucks was still growing.
But that all changed in the third quarter of 2016, when comparable sales growth came in at just 4%. That marked the first time comps slipped below 5% since the first quarter of 2010. Meanwhile, transaction growth came in flat, yet another first in multiple years.
The next quarter, comparable sales growth stayed below 5%, while transaction growth actually fell into negative territory (-1%). The following two quarters, transaction growth stayed at -1%, while comparable sales growth fell to just 3%. Last quarter, transaction growth stabilized to flat, but comparable sales growth remained below 5%.
Overall, then, Starbucks has broken a multiyear trend of 5% comparable sales growth with five consecutive quarters of comparable sales growth below 5%. Transaction growth has not been positive in that stretch.
What is happening under the hood?
Starbucks has a whole bunch of new competition in the form of indie coffee shops and all-day breakfast offerings from traditional fast food giants. Indie coffee shops are popping up everywhere, and these hipster spots have stolen the trend-focused millennial crowd. Meanwhile, the price-focused crowd is now going to McDonald’s Corporation (NYSE:MCD), whose all-day breakfast initiative has been a huge hit.
With all this new competition, SBUX comparable sales growth is slowing. That competition isn’t going away anytime soon, so SBUX is now settling into this era of slower growth defined by sub-5% comps.
Valuation on SBUX Stock Is Still Too Rich
But Starbucks stock hasn’t come down enough to appropriately reflect this lower-growth era.
Here is how I look at SBUX stock from a numbers perspective.
SBUX earnings have skyrocketed from $0.81 per share in 2011 to $1.90 per share in 2016. That represents growth of roughly 19% per year. On average, the market has paid around 30 times earnings for that 19% growth. That means the market is used to paying nearly a 60% premium to growth for SBUX stock (30 divided by 19).
Let’s extrapolate that 60% premium over the next several years. Growth over the next five years will inevitably slow due to the law of large numbers and a rise in competition. The Street is looking at 15% growth over the next 5 years. That feels about right to me, although slightly on the aggressive side (my model calls for 13% growth).
Let’s aggressively call it 15%. Throw a 60% premium on that 15% growth estimate. That gets you to a “fair” price-to-earnings multiple of about 24. A 24-times multiple on fiscal 2018 earnings estimates of $2.35 implies a one-year price target of about $56.
Bottom Line on SBUX Stock
SBUX stock currently trades at $54. My price target implies 4% upside over the next 12 months.
In this bull market, 4% return is anemic.
Consequently, I think SBUX stock is best avoided at these levels. At best, this stock trades largely sideways over the next 12 months.
As of this writing, Luke Lango was long MCD.