For the past nine months, Starbucks (NASDAQ:SBUX) stock has been in major rally mode, as the global retail coffee giant has regained some operational momentum. SBUX has successfully carried out some key growth initiatives which together have reduced the company’s competitive pressures.
The company’s comparable sales and traffic trends have improved globally, and Starbucks stock has risen more than 50% from its late June 2018 lows.
It appears that the rally of Starbucks stock can continue deep into 2019. There are reasons to believe that its traffic trends will remain favorable for the balance of the year, and that those favorable trends will combine with really easy year-over-year comparisons to make the company’s results look very good. If that scenario plays out, SBUX should report really strong numbers throughout the balance of fiscal 2019, likely keeping SBUX stock on a winning path.
But the rally of Starbucks stock is likely to be challenged by fundamental risks. Namely, the long-term growth outlook of Starbucks stock is slowing, its competitive risks are still building, and Starbucks stock is priced for perfection. At some point in time, these fundamental risks will affect SBUX, and Starbucks stock will fall.
But that won’t happen now. For the time being, SBUX stock looks unstoppable, as it’s regaining global operational momentum.
On the Bright Side
SBUX stock looks unstoppable in the near-term because its global comparable sales and traffic trends are poised to keep improving in 2019.
On a global basis, its comparable-sales growth was 4% last quarter, the strongest gain since the third quarter of 2017. Meanwhile, its traffic was flat after three consecutive quarters of negative traffic growth. Furthermore, as fiscal 2019 progresses, its comparisons will only get easier, as 2018 was a year defined by largely negative traffic growth and 3%-and-under comparable sales growth.
In the U.S., Starbucks has rattled off back-to-back, 4% comparable sales growth quarters for the first time since late 2016. Traffic growth was also flat last quarter after two consecutive quarters of declines. Consistent with the global narrative, the comparisons for the company’s U.S. business only get easier as fiscal 2019 progresses.
It’s the same story in the China-Asia Pacific and Europe, Middle East, and Africa regions. Comparable sales and traffic growth hit multi-quarter highs in both areas last quarter, and the comparisons for the rest of the year in those regions will be pretty easy, too.
All in all, SBUX is firing on all cylinders right now and should continue to do so for the foreseeable future. The company is leveraging digital innovation, an enhanced mobile ordering experience, renovated stores and drive-thrus, menu innovations, and relevant celebrity partnerships to win back breakfast snack and drink market share. Its strategy is working and will continue to work, mostly thanks to celebrity partnerships in 2019 and easy comparisons.
Thus, Starbucks’ results will remain good in 2019. As long as those numbers remain good, Starbucks stock will likely stay on a winning path.
Some Things to Worry About
Although SBUX stock is positioned to stay on a winning path in the near- term, Starbucks stock is facing fundamental risks which could derail the rally.
The first big risk is that the company’s growth is slowing. A few years back, SBUX was well-known for its track record of consistently reporting 5% or higher comparable sales growth. That streak broke in mid-2016. Since then, SBUX’s quarterly comparable sales growth has not reached 5%. That won’t happen anytime soon, either, as its consolidated comparable sales growth is expected to be around 3%-4% over the long-term.
Some investors are buying Starbucks stock as if this company is doing as well as it ever has. But it’s not. Its growth is slowing, and that’s a problem.
The second big risk facing Starbucks stock is that its growth will continue to slow thanks to still-strengthening competition. Specifically, McDonald’s (NYSE:MCD) continues to expand its presence in the breakfast snack and drink category. That creates sales, traffic, and margin pressures on SBUX. Meanwhile, independent coffee shops continue to open up left and right. There’s also a new craft coffee trend that could hurt Starbucks’ results.
Given all these competitive risks, it’s likely that once the company’s comparisons gets harder and its boost from celebrity partnerships cool, Starbucks’ growth will slow. When that occurs, Starbucks stock will drop.
The third big risk facing Starbucks stock is valuation. SBUX stock is priced for perfection. The stock trades at 27 times analysts’ consensus forward earning estimate. Over the last five years, the average forward multiple of Starbucks stock was 25, and during part of that stretch, its comparable sales growth was much higher (5% and up) than what it is expected to be over the next five years (3%-4% or lower). So the valuation of SBUX stock seems stretched at this point. Any bad news could cause the valuation of SBUX stock to drop meaningfully.
The Bottom Line on Starbucks Stock
SBUX is a solid company, but the valuation of Starbucks stock today is overly optimistic, given the company’s long-term growth outlook. As long as the company’s results remain good, SBUX stock can maintain its overly optimistic valuation and head higher. Eventually, though, the company’s numbers will miss expectations. When they do, SBUX could drop in a big way.
As of this writing, Luke Lango was long MCD.
