Starbucks (NASDAQ:SBUX) often can be relied upon to be ahead of trends, but there is a really important trend that Starbucks stock doesn’t seem to be ready to lead the way on.
A big late 2018 sell-off in equities spurred by recession fears, followed by a blowout December jobs report which put to rest those recession fears, implies that the outlook for stocks to rise over the next several months is quite favorable. Broadly speaking, the financial markets should be a tide that lifts most boats in the first half of 2019.
In simple terms, the fundamentals underlying Starbucks stock aren’t that good and the valuation is still stretched, a combination which more often than not results in a weak stock.
To be sure, Starbucks is a great company. This is the global coffee giant. Growth will remain good and steady over the next several years. Margins should remain stable. The dividend is safe. The balance sheet is secure. These are all good things that will keep SBUX on a long term uptrend.
But, gains in the near to medium term will be muted by operational risks and a stretched valuation. With that in mind, let’s take a look at four reasons to avoid Starbucks stock for the foreseeable future.
1. Coffee Isn’t As Popular as It Used to Be
A big problem for Starbucks is that today’s kids don’t drink as much coffee as their parents, and that’s because they are more health-conscious than their parents and are opting for more health-oriented drinks like teas and cold-pressed juices.
According to a YouGov survey, coffee is far more popular than tea among every age demographic except for the 18 to 29 year-old demographic, where the two have equal popularity. Also, the cold-pressed trend is as strong as ever among younger consumers, while drinks like kombucha have soared in popularity over the past several years.
Under the hood, what you have here is a secular shift among younger consumers towards healthier and more active lifestyles. Coffee has always been in the gray area in terms of being good or bad for people. Consumers are increasingly shunning gray area items like coffee, and instead adopting healthier alternatives.
This trend won’t let up anytime soon. Granted, Starbucks has a huge presence in the tea market, so they are braced for this impact somewhat. But, there will be a swath of consumers over the next several years who quit Starbucks entirely in order to be “healthier,” and that’s a sizable operational risk for Starbucks stock.
2. Competition Is Bigger Than Ever
The big thing that has weighed on SBUX over the past several years is bigger competition from quick service restaurants like McDonald’s (NYSE:MCD) and indie coffee houses like Peet’s. This headwind won’t ease anytime soon.
McDonald’s is only getting more aggressive in the breakfast drinks and snacks game. The more aggressive they get, the more price-sensitive consumers will turn their morning Starbucks runs into morning McDonald’s runs.
Moreover, if the economy does slow meaningfully, non-price-sensitive consumers will turn into price-sensitive consumers, meaning there could be a mass exodus from Starbucks and to McDonald’s.
On the indie front, things aren’t prettier. Instagram culture is as strong as ever. Indie coffee shops have Instagram appeal. Starbucks does, too, but not to the same extent.
As such, so long as younger consumers remain obsessed with sharing their favorite morning drinks through pictures, indie coffee shops will keep rising at the expense of Starbucks.
3. The China Growth Narrative Looks Weak
A huge, and arguably the biggest, peg of the Starbucks stock bull thesis is robust growth potential in China. But, that peg of the SBUX bull thesis looks weaker and weaker by the day.
First, the trend isn’t your friend here. In 2011, Starbucks China was posting comparable sales growth in excess of 20%. Last year, comparable sales growth was just 1%. Meanwhile, the Chinese economy is growing at its weakest rate since the financial crisis, and GDP growth is expected to keep falling over the next several years. Thus, the trends here are deteriorating and only getting worse.
Second, Starbucks isn’t immune to competition overseas. McDonald’s has a big presence in China and in other emerging markets. If economic weakness in those markets persist, McDonald’s will likely steal share from Starbucks due to its lower price appeal.
Also, there’s a nascent but rapidly growing and lower-priced coffee chain in China called Luckin Coffee that presents a huge risk to the Starbucks China growth narrative.
4. Valuation Is Still Stretched
Despite all the aforementioned operational risks from slowing growth and rising competition, Starbucks stock still trades at a premium valuation.
The stock’s forward multiple currently hovers around 24. That is a big multiple on it’s face. It is far bigger that the market average forward multiple of 15. It also bigger than the restaurant sector’s average forward P/E multiple of 22.
To be sure, it is below the five year average valuation on Starbucks stock, which is 25 forward earnings. But, it’s only a hair below that average, while the fundamentals are far worse than where they were over the past five years.
As such, the valuation on SBUX remains unnecessarily stretched.
Bottom Line on SBUX Stock
Long term, Starbucks stock will be just fine. But, near to medium term gains will be capped by increasing operational risks against the backdrop of a still unnecessarily stretched valuation. As such, Starbucks stock looks like a name to avoid for the foreseeable future.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
