Full disclosure: I think shares of Starbucks (NASDAQ:SBUX) are slightly overvalued above $70, and that long-term fundamentals do not support prices at these levels for the retail coffee giant until the end of 2019. Having said that, I also understand that fundamentals don’t always drive near-term stock price movements. Those can be (and are often) driven by narratives and sentiment.
From the narrative and sentiment window, I think that Starbucks will improve dramatically in 2019, driven mostly by a healthy rebound in U.S. traffic growth thanks to a new partnership with singer-celebrity Ariana Grande. Investor sentiment will improve alongside that improving narrative. As such, it does appear as though Starbucks stock has upside potential in 2019.
To be clear, this doesn’t mean Starbucks stock isn’t overvalued. It is. But, when the narrative is good and investor sentiment is bullish, overvalued stocks can continue to rise, despite the fundamentals.
That’s exactly what will happen in the first part of 2019 for Starbucks stock. This overvalued stock will keep rallying because of a few landmark catalysts which keep the bulls in control.
At the end of the day, this rally won’t be sustainable. Fundamentals will eventually catch up to Starbucks stock, and it will drop. But, not yet.
The Narrative for Starbucks Stock Will Improve In 2019
There has been one big headwind which has weighed on the SBUX growth narrative over the past few years. Namely, Starbucks has ceded mind and market share to both cooler competitors like indie coffee houses, and cheaper competitors like McDonald’s (NYSE:MCD). This headwind will materially improve in 2019, thereby improving the SBUX growth narrative, which will in turn bolster investor sentiment and push Starbucks stock higher.
There isn’t much Starbucks can do about the McDonald’s threat. McDonald’s always has been, still is, and will probably always remain cheaper than Starbucks. As McDonald’s builds out its breakfast drink and snack menu, price-oriented consumers will continue migrate to McDonald’s.
But Starbucks can do something about the indie coffee shop threat which has poached trend-oriented consumers. Indeed, Starbucks has already taken action to win those customers back.
Specifically, the company has partnered with singer-celebrity Ariana Grande. That’s a big deal. Ariana Grande is among one of the most followed celebrities on social media. Her nearly 150 million Instagram followers make her the third-most-followed person on all of Instagram, while her 60 million-plus Twitter (NYSE:TWTR) followers make her the eleventh-most-followed person on that platform. For all intents and purposes, her reach and influence among young consumers is second-to-none.
Starbucks now has that second-to-none reach and influence on their side, at a time when they desperately need it. Starbucks hasn’t reported a positive U.S. traffic growth number in twelve quarters, nor have they reported 5% or higher U.S. comps in seven quarters. With Ariana Grande recharging millennial interest in the brand, both of those things could happen in 2019, especially considering the weak traffic laps (U.S. traffic was down 3% in 3Q18).
If that happens, Wall Street will celebrate. Analysts will talk up the company’s re-charged U.S. momentum, and investors will get excited about the prospects of Starbucks once again turning into a 5%-plus comparable sales grower. SBUX stock will consequently head higher, regardless of valuation.
The SBUX Fundamentals Still Stay Overvalued
Any big rally in Starbucks stock in mid-2019 as a result of improved U.S. traffic trends will not be sustainable.
Why? Because in the long run, Starbucks is already priced for improved global traffic trends, and then some. Plus, the improvements in 2019 will be because of weak laps and a one-time catalyst, two things which won’t persist into 2020 or beyond. Meanwhile, the McDonald’s headwind isn’t going away, indie coffee shops are still aggressively expanding and China’s economy is still slowing.
In other words, the big picture narrative here is still one defined by stable yet slower growth going forward. Assuming Starbucks can continue to grow comps at a mid-single-digit but sub-5% rate in the long run, revenues grow at a mid-to-high-single-digit rate, and operating margins stabilize in the 17%-18% range, a reasonable long-term EPS target for Starbucks is $4.85 EPS by fiscal 2024.
Based on a restaurant average 20 forward multiple, that implies a reasonable fiscal 2023 price target for Starbucks stock of nearly $100. Discounted back by 8% per year (two points below my normal 10% discount rate to account for the yield), that equates to a fiscal 2019 price target of just over $70.
That is exactly where Starbucks stock trades today. Thus, while upside in the near term looks compelling, it isn’t fundamentally sustainable in a long-term window.
Bottom Line on SBUX Stock
Starbucks stock will head higher in early to mid 2019 thanks to strong quarterly numbers which will show improvements in U.S. traffic trends for the first time in several years. But that rally will not be sustained, since long term fundamentals imply that Starbucks stock is already slightly overvalued.
As such, SBUX stock seems like a case of “buy now, sell later.”
As of this writing, Luke Lango was long TWTR.
