Starbucks Corporation Stock Is Far From a Sure Thing

Starbucks stock is getting cheaper and with good reason

By Ian Bezek, InvestorPlace Contributor

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SBUX Stock Is Far From a Sure Thing

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Starbucks Corporation (NASDAQ:SBUX) needs a jolt. Shares of the ubiquitous coffee shop chain have lost their buzz in recent quarters. In fact, over the past year, SBUX stock is down slightly. That’s a huge disappointment compared to the market, which is up 17% over that time.

The most recent earnings report did nothing to give Starbucks stock a boost. The company reported another slow quarter, with its limited-time holiday offerings performing particularly poorly. 2017 only adds to recent woes, and Starbucks is simply unable to grow like it used to. But with SBUX stock getting cheaper, is the lack of growth worth overlooking?

Too Many New Stores

Starbucks seems set on growth at all costs. Last year, Howard Schultz, founder and executive chairman of Starbucks, laid out a plan to take Starbucks’ then 26,000-store count up an astounding 11,000 to 37,000 by the year 2021. Years ago, The Onion even joked that Starbucks would open a new location inside the bathroom of an existing Starbucks.

But the level of cannibalization is getting crazy. A BMO report from last summer noted that the average Starbucks store has four other Starbucks within a mile of its location. At that point, how much more growth is possible?

At some point, the market is simply tapped out. And that’s even before you consider the competitive threat from fast-growing rivals such as Dunkin Brands Group Inc (NASDAQ:DNKN).

Schultz has previously said that new store openings didn’t hurt existing locations. But at some point, people will simply have enough Starbucks stores near them, and building yet another one won’t boost marginal consumption.

It’s worth noting that Starbucks’ last hyper-growth phase, as detailed in Schultz’ book Onward, occurred in the mid-2000s. The company raced to open thousands of stores inside of a two-year period. Schultz described what happened next:

“It was staggering. We were closing almost 20 percent of our newest stores! We thought all we had to do was show up to be successful, I thought to myself. As I stared at the list of 600 [stores about to be closed] a lesson resonated: Success is not sustainable if it’s defined by how big you become.”

History Repeats

For whatever reason, Starbucks seems to have forgotten this lesson. The company grew too quickly during economic good times, setting up an outright crash in 2008. The company had to close a large portion of its store base, and SBUX stock collapsed. Shares declined 75% peak-to-trough, performing far worse than the broad market.

And yet, many years into an economic expansion, Starbucks is again going for unrestrained growth. What’s going to be different this time? It’s not clear. Other previous errors made in the 2006 era — such as emphasizing food rather than coffee — are being repeated again today.

Not surprisingly, Starbucks’ rapid growth and dilution of its core mission are leading to soft sales. The company reported just 1% same-store sales growth for the pivotal holiday quarter. It’s never good news when SBUX stock, previously priced as a growth dynamo, has to support itself on 1% organic growth that couldn’t even keep up with inflation.

For many quarters now, Starbucks keeps telling us that things will turn around. Sales growth is about to come back, we hear. But it just isn’t happening.

Some of the fault is on management for alienating customers. Unpopular changes to the loyalty program, along with divisive political stances have certainly turned off some customers. But more broadly, the market is full. Americans already drink a ton of coffee, and they pay a lot for it. At some point, new stores just can’t do much to move the needle.

Betting on China

This brings us to Starbucks’ big push. They’ve now tapped out much of the low-hanging international market. Witness their recent launches in Italy, Colombia and other proud coffee cultures where American-imported cafes are unlikely to go over well. SBUX feels the need to grow and will go almost anywhere for more stores.

When thinking of growth, you have to consider China. As the world’s largest middle class, it is the ultimate target for aspirational brands. Within a few years, China is likely to be the single largest source of profits for companies selling high-end consumer goods. So it’s no surprise that Starbucks is making a major play for China.

One problem, though. China isn’t so enamored with coffee. As of 2016, China’s coffee consumption remained extremely low, around three cups of coffee per person per year.

China has historically been a tea-drinking country. Starbucks is betting that it can change this attitude, and initial signs are promising. SBUX is reporting 6% same-store sales growth out of China in recent quarters, far ahead of its growth rates in other markets.

But I’m skeptical that these growth rates will hold. For now, SBUX is a luxury brand that consumers gravitate toward, even if they don’t love coffee. New trends wear off over time, though. If Chinese consumers don’t embrace the taste of coffee in a major way, look for Starbucks’ gains to be fleeting.

SBUX Stock Outlook

SBUX stock has traded in a range between $50 and the low $60s since 2015. As such, its current sub-$55 price is interesting. Against a stock market racing higher, Starbucks looks like a relative value. Additionally, it is now selling at just 19x forward earnings. That’s the cheapest it has been in quite a few years.

Starbucks now offers a respectable yield, as its dividend is up to 2.2%. Just recently, SBUX yield topped that of the S&P 500 for the first time in its history. With its rapid dividend growth rate and more reasonable starting valuation, Starbucks is becoming a decent choice for growth and income investors.

But its rising dividend yield is indicative of another thing. Starbucks’ growth story isn’t fooling people anymore. The company’s days of rapid growth are just about over. The China expansion is the final frontier, and if it succeeds, Starbucks gets a few more years of double-digit EPS growth. If not, Starbucks rapidly converts to a slow or no-growth cash flow story.

And for that sort of company, even 19x earnings may be a touch expensive. SBUX stock is certainly more interesting at this price than it was three years ago. But it’s far from a sure thing here, either.

At the time of this writing, the author held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.


Article printed from InvestorPlace Media, https://investorplace.com/2018/02/starbucks-stock-is-far-from-a-sure-thing/.

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