There are a few stocks which I haven’t liked for several years now. One of them is Starbucks Corporation (NASDAQ:SBUX). After a huge run in 2015, Starbucks stock was heading into 2016 with a forward earnings multiple in excess of 30. That is a valuation normally reserved for hyper-growth technology giants with multiple years of 20%-plus earnings growth ahead.
But Starbucks is not now nor has it ever been a hyper-growth technology company. It’s a coffee house. Granted, it’s a very good coffee house with a world class brand. But at the end of the day, Starbucks is still just a coffee house.
Ever since its forward earnings multiple bumped to above 30, Starbucks stock has been stuck in neutral. Since the start of 2016, the S&P 500 has rallied more than 30%. Meanwhile, SBUX stock has dropped 4% in that time frame.
Will this sideways trading continue? I think so.
SBUX stock remains overvalued considering its weakening growth prospects in an increasingly crowded breakfast drink and snack category. As such, I think this stock trades down to $50 before it takes a meaningful leg higher.
Here’s a deeper look:
Problems on the Competition Side
The big problem with Starbucks stock over the past few years is that growth has come off the hinges.
This used to be a company that consistently reported comparable sales growth of 5% or higher. Indeed, earlier this decade, Starbucks reported 25 consecutive quarters of 5% or greater comparable sales growth.
In 2016, that streak ended. And comparable sales growth has not been above 5% since. Actually, comparable sales trends have only deteriorated since. In the back-half of 2016, comparable sales growth was 4%. In 2017, it was 3%. So far in 2018, it is just 2%.
What is going on the under hood here? Beefed up competition.
Namely, trendy indie coffee shops are stealing the trend-oriented consumers, while fast-casual chains like McDonald’s Corporation (NYSE:MCD) are stealing the price-sensitive consumers. On the trendy side, trend-oriented consumers enjoy the anti-corporate, more homey feel of indie coffee shops, which are popping up everywhere, and that has eroded trend-oriented customer loyalty at SBUX.
Meanwhile, on the price-side, price-oriented consumers are fleeing to McDonald’s and other fast-casual chains who are building out their breakfast menus while still keeping every-day low prices.
At the end of the day, SBUX is stuck in this gray area of not offering the best prices and also not being the coolest option in town. Because of that, SBUX growth will remain weak into the foreseeable future.
Starbucks Stock Needs to Fall Some More
SBUX stock still trades at 23-times forward earnings, which seems a little rich considering the company’s growth.
Last quarter, comparable sales rose 2%. Revenues rose 14%. Operating profits rose just 3% due to heavy margin compression.
Comparable sales growth of just 2% is at odds with a 23-times forward earnings multiple. So is an operating profit decline of 3%.
Overall, over the next several years, SBUX should be able to grow revenues in the high single-digit range thanks to unit expansion in developing markets, specifically China. But comparable sales growth over the next five years will likely stay in the low single-digit range, meaning there won’t be much room for operating leverage.
As such, operating margins, which have hovered below 20% for the past several years, will at-best expand to 20% in 5 years.
Those assumptions lead me to believe that SBUX can net around $3.70 in earnings per share in five years. A market-average growth stock multiple of 20-times forward earnings on $3.70 implies a four-year forward price target of $74.
Discounted back by 10% per year, that equates to a present value of just above $50.
Bottom Line on Starbucks Stock
Starbucks stock has gone nowhere for two-plus years. Considering competition is only ramping in the company’s core breakfast drink and snack category, and the valuation on the stock remains rich, it looks like SBUX stock will continue to be weak into the foreseeable future.
As of this writing, Luke Lango was long MCD.
