Global retail coffee giant Starbucks (NASDAQ:SBUX) just wrapped up its annual Investor Day, and the takeaway is mixed. Analysts are hiking long-term estimates and upgrading SBUX stock. But, investors aren’t buying it, and instead, SBUX stock is deep in the red following its Investor Day presentation.
Why the split feelings? Analysts are positive on the delivery build-out with UberEats and the super-charged China growth narrative. Investors are concerned that despite those catalysts, comparable sales, revenue, and earnings growth going forward are expected to be sub-par.
When it comes to SBUX stock, I think the bears are right. At the current price, SBUX stock doesn’t look very compelling. The valuation is full. The growth drivers have red flags. And, the business still has going competition risks which haven’t been resolved.
As such, I think it’s best to avoid SBUX stock here and now. The upside thesis simply doesn’t look that good.
China Is The Company’s Growth Engine, But China Is Slowing
When it comes to SBUX stock, the one thing that everyone seems most excited about right now is the company’s growth potential in China.
Management raved about it during Investor Day. Over the course of the next four years, Starbucks plans to grow its China store base from 3,600 to 6,000, while expanding its presence from 150 cities to 230 cities. That’s big growth. It’s no wonder why bulls are hanging their hat on China driving growth as the U.S. business slows.
But, bulls are hanging their hat on something that is getting weaker by the day. China’s economy has been slowing for a while, and recent data implies this slowdown is only getting worse. Retail sales in China rose just 8.1% in November, below expectations and marking the slowest pace since 2003. Meanwhile, industrial production rose just 5.4%, the slowest pace since 2016.
Broadly speaking, the China economic growth is rapidly cooling. That means Starbucks’ biggest potential tailwind over the next several years is rapidly cooling. That isn’t good news, especially if you consider what Starbucks is. In the retail coffee landscape, Starbucks is at the premium end in terms of price. McDonald’s (NYSE:MCD) is far cheaper, and has a big presence in China. If the economy continues to slow, chances are that Chinese consumers will start switching their morning Starbucks runs, with morning McDonald’s runs.
Digital Delivery Means More Growth, But Lower Margins
The other big growth driver that SBUX stock bulls are excited about is expansion of the Starbucks digital delivery ecosystem. Specifically, the company is partnering with UberEats to bring digital delivery functionality to 3,500 U.S. locations.
That’s great news. For revenue growth. Digital delivery is the future, and the more Starbucks immerses itself in this space, the higher comparable sales growth will trend.
But, there’s also a major red flag here. Digital deliver is lower margin. The delivery company — in this case, UberEats — has to take a cut. That means higher costs and lower margins. Thus, while sales might get a boost from the digital delivery tailwind over the next several years, it will be at the expense of margins, meaning profit growth won’t be that great.
Valuation Is Full Considering Risks
In the big picture, the two big growth drivers for SBUX stock (China and digital delivery) come with red flags. Also, the competition headwind from lower cost and trendier options in the U.S. hasn’t gone away, and comparable sales growth in the U.S. remains as weak as its been a decade.
Despite these risks, SBUX stock still trades at 25 forward earnings. That’s a pretty big multiple. The market is trading at 15 forward earnings. Fast casual peers McDonald’s and Dunkin’ (NASDAQ:DNKN) trade around 20 to 22 forward earnings. The whole restaurant industry trades around 23 forward earnings.
In other words, SBUX stock’s 25 forward multiple is bigger than what you see at most comps. It’s also in line with the stock’s trailing five year average valuation. But, during those five years, comparable sales growth was largely 5%-plus. Over the next several years, it is expected to be between 3% and 4%.
All things considered, the valuation on SBUX stock is pretty full here. You have a stock trading at a normal valuation level, with slower-than-normal growth prospects and bigger-than-normal operational risks. That isn’t a great combo.
Bottom Line on SBUX Stock
There’s three reasons not to like SBUX stock here. The China growth narrative is threatened by a slowing China economy, the digital delivery tailwind comes with lower margins and the stock is fully valued despite still sluggish global growth.
SBUX stock may work from here. It isn’t terribly overvalued and the growth narrative isn’t broken. But, upside seems limited, and the risk/reward skews heavily towards the downside considering the aforementioned risks.
As of this writing, Luke Lango was long MCD.