Starbucks Stock Is Simply Too Hot

SBUX stock is near its all-time highs, but investors may be ignoring the obvious risks that SBUX is facing

I’ve been bearish on Starbucks (NASDAQ:SBUX) stock for some time now. That skepticism looked prescient a year ago, when SBUX stock touched its lowest levels in almost three years. Since then, however, Starbucks stock has soared: SBUX at the moment trades near its all-time high.

Why Starbucks (SBUX) Stock Looks Overheated at Current Levels
Source: Shutterstock

Despite the volatility of the stock, Starbucks’ outlook doesn’t seem to have changed all that much. Starbucks’ business is up there with McDonald’s (NYSE:MCD) as one of the best in the world.

But the valuation of SBUX stock has been worrisome for a long time, and SBUX is facing meaningful risks. By placing a huge bet on China, SBUX has made a wager that looks increasingly dicey as the economy in that emerging market shows signs of slowing down. Meanwhile, the same-store sales and traffic growth of Starbucks’ U.S. business has slowed.

While SBUX stock has gained a whopping 50% from its late-June lows, its risks persist. In fact, several of those risks were highlighted in the company’s first-quarter results last month that helped push Starbucks stock to its current highs. Given those concerns, and an increasingly stretched valuation, it looks like SBUX stock has run too far.

Starbucks’ Q1 Earnings

Looking at the headline Q1 numbers, investors could easily believe that SBUX did well. Propelled by a 4% same-store sales increase, its revenue rose 9%. Adjusted earnings per share climbed 15% year-over-year. Both figures were nicely ahead of analysts’ consensus outlook, and seem to foreshadow a potentially strong fiscal 2019.

But the quarter isn’t nearly as impressive as it seems on the surface. Comp growth of 4% seems impressive, but three of the four percentage points were generated by price hikes. In the U.S., traffic was flat year-over-year (as it was in the same period a year earlier), further suggesting that the business has reached a saturation point domestically. In China, comps rose just 1% year-over-year, while the number of transactions declined 2% YoY.

Meanwhile, the company’s earnings growth came almost solely from a lower tax rate. Adjusted operating income actually declined 1.2% YoY. Margins dropped 1.7 percentage points.

Still, there are reasons to worry about the company’s near-term profit outlook, even though its sales are growing. And some of the longer-term concerns raised by the company’s Investor Day late last year haven’t eased.

SBUX stock now trades at almost 26 times the midpoint of its updated EPS guidance. That’s a high valuation, and one that suggests that everything will keep going smoothly.

Has SBUX Stock Peaked?

From here, $71.54 looks like a potential peak for SBUX stock. The 26 multiple is towards the high end of the company’s multi-year range. It’s a multiple that likely requires the U.S. stock market and the company’s overseas business to continue to be strong.

Starbucks still is adding new stores in the U.S. But the pace is slowing; its domestic store count rose just 4% year-over-year last quarter. With nearly 15,000 stores, SBUX likely is running out of room.

And its European business is improving, as a turnaround there takes hold. But the big growth driver of Starbucks stock is China.

Luke Lango argued on this site that the struggles of Apple (NASDAQ:AAPL) in China raised some concerns about the country’s economy, and he makes a good point. Clearly, Chinese customers are more budget-conscious than they were a year ago.

Weakness in China won’t bring Starbucks’ growth story to an end. But it certainly would slow SBUX down and hurt SBUX stock. I noted in December that Starbucks already has brought down its long-term EPS growth target to roughly 10% per year from 12% previously. Unexpected troubles in China would drop that growth to the single-digits. And as embedded as Starbucks is in the U.S., in particular, it’s tough to see investors paying 26 times earnings for 8%-9% annual EPS increases.

The risk facing SBUX stock is not necessarily that  Starbucks’ growth is going to stop, but that it will slow enough to give investors pause. Currently, SBUX’s FY20 EPS is on a pace to be about $3; cut that figure to $2.90 and bring the EPS multiple down to a still-reasonable 21 times, and SBUX stock would drop to $60. Add in any macro worries in the U.S. or Europe and the decline could be steeper.

Be Careful With Starbucks Stock

All told, it does look like SBUX is approaching a ceiling. It’s difficult to imagine its earnings multiple expanding much more. SBUX may outperform expectations this year, but it’s seemingly equally likely that it could stumble, particularly in Asia.

SBUX stock shouldn’t be shorted, by any means; it simply seems like there are better, and potentially easier, ways to make money. A few good quarters have sent Starbucks stock 50% higher. It would probably only take one bad quarter to reverse at least some of those gains.

As of this writing, Vince Martin has no positions in any securities mentioned.

 


Article printed from InvestorPlace Media, https://investorplace.com/2019/02/starbucks-stock-sbux-stock-simply-hot/.

©2019 InvestorPlace Media, LLC