From a single location in 1987, Starbucks (NASDAQ:SBUX) has grown to over 31,000 stores to elevate coffee culture to a new level both in the U.S. and in many other countries. Starbucks stock has doubled since the lows of June 2018 and is currently hovering around $93.
The company is expected to report Q1 FY2020 results Jan. 28. Now investors are wondering if they should buy into Starbucks at these levels.
In general, winners keep winning in the stock market. Starbucks, the top coffee chain globally, has a great core business and its stock is likely to keep rewarding investors well into the future.
However, given the recent impressive gains in the stock price, especially since Nov. 2019, I expect short-term profit-taking in Starbucks. Thus, unless your portfolio can weather some volatility, I’d personally hold off buying the company until a pullback occurs.
Let’s see why …
What to Expect from Starbucks Earnings
The coffee giant whose history dates back to 1971, went public in 1992. Since its initial public offering (IPO) in 1992 at an initial price of $17, Starbucks has had impressive growth. Over the years, the stock has split several times; it has also been paying dividends since 2010. The current dividend yield stands at 1.75%.
When it reported Q4 earnings in Oct. 2019, earnings came in line with expectations. Revenue rose $6.75 billion from $6.3 billion in the year-ago quarter.
Of particular interest was the increase in same-store sales, or how existing stores perform over time. The U.S. business delivered 6% comparable-store sales growth. Similarly in China, despite growing competition from Luckin Coffee (NASDAQ:LK), comparable-store sales grew by 5%.
As Starbucks stock reports next week, analysts will likely pay close attention to the key metric of comparable store sales, given the recent news of Chinese economic slowdown. As a consumer discretionary company, Starbucks could easily face greater pressure in an economic downturn. Unless it shows further steady growth, there may be a downward bias in the stock price.
When we remember that its market cap currently stands at $110 billion, it is easy to see how big that number is. If the U.S. or global economy slows down, management simply cannot continue with the share repurchases.
Therefore the boost to the stock price from share buybacks may be coming to an end.
Further Tailwinds for Starbucks Stock
Power of the Brand Reinforces High Margins: Over the past three decades, Starbucks has evolved from a local concept into a global brand. Long-term investors should consider the strength of the group’s brand: Starbucks is regarded as the “most valuable” restaurant brand.
Currently, Starbucks derives most of its revenue from high-margin specialty drinks. Its net profit margin is over 13%. For most U.S. consumers, it is the new normal to pay $4 or even a lot more for a cup of coffee. The company has indeed built a strong model for sustained success.
This advantage is reinforced by the consistency of product quality worldwide: Starbucks is diligent about ensuring that the quality of its products and its customer service is consistently good in all its global units. Therefore, Starbucks and its product line are not likely to fall out of favor any time soon.
Chinese Growth: Starbucks certainly relies on its brand as the group increases its presence in China. Now it has over 4,100 stores in China, making the country its second-largest market after the U.S.
Traditionally, China is a tea-drinking country. Coffee growers and chains like Starbucks are excited by the potential in the country as the market is expected to grow almost 10% per year.
Management is optimistic regarding the long-term-potential China offers. It has also highlighted Alibaba (NYSE:BABA) as “an important driver” for its digital growth. The company has also recently been named one of the best employers in China. Thus the country is a particular growth opportunity that long-term Starbucks investors cannot ignore.
What Could Derail Starbucks Stock?
Stock Valuation Amidst Competition: In the U.S., the coffee shop market is fast approaching a $50 billion valuation. Yet, the space is now quite saturated. Starbucks’ main chain competitors include McDonald’s (NYSE:MCD) and Dunkin’ Brands (NASDAQ:DNKN).
From these big names to smaller high-end local specialty coffee shops, competition is aiming to take a slice of market share, either by undercutting Starbucks on price or offering a different and “better” in-store customer experience.
At a forward P/E of almost 31, to me the shares look a bit on the rich side. I’d be more comfortable with a number between 20-25. Weakness in China or domestically could easily dampen growth prospects in the near term.
Short-Term Profit Taking: With the recent run-up in the stock price, Starbuck’s short-term technical indicators have become somewhat over-extended. In the coming weeks, Starbucks stock may trade sideways, or even have a pullback toward the low-$80’s level, where the stock is likely to find major support.
Therefore, if you already own SBUX, you might want to hold your position. That said, if you are worried about short-term profit-taking and if you are an experienced investor in the options market, you may also consider protecting your portfolio with a covered call.
For example, you could consider buying 100 shares of SBUX around $93 and at the same time selling a Feb. 21 $92.5 call option, which currently trades at $2.95. The $92.5 option is slightly in-the-money (ITM), offering downside protection in case of volatility and a decline in SBUX stock. It would also enable you to participate in a potential up move in the share price.
This call option would stop trading on Feb. 21, 2019 and expire on Feb. 22.
The Bottom Line on Starbucks Stock
Starbucks is synonymous with premium coffee as well as affordable indulgence. In the past year, Starbucks stock has significantly outperformed the S&P 500, rising about 45%.
When investors purchase a stock, they also make a claim against that company’s future earnings. They believe that their investment will generate returns that will beat those of the broader stock market over the long term. Currently, Starbucks has the largest number of stores worldwide within the coffee chain industry. It also generates the most revenue.
Finally, Starbucks is a favorite with a range of exchange-traded funds (ETFs) and mutual funds, increasing the demand for the stock. For example, the largest ETF holder of SBUX is the SPDR S&P 500 ETF (NYSEARCA:SPY), with approximately 13.76 million shares. On an anecdotal note, according to Robinhood, a trading app, Starbucks stock is one of the most popular on its trading platform.
Are more gains ahead for Starbucks stock? It’s impossible to know for sure, but there are reasons to believe that the stock price could see new highs. Although there might be some profit-taking in the coming weeks, any dip in the price of Starbucks stock could be regarded as an opportunity to go long in SBUX.
I would not advocate bottom-picking in case of near-term price weakness. Yes, there may be bumps in the U.S. or China. Yet, I find Starbucks to be a compelling buy candidate and, I’d expect the shares to go over $100 by the end of 2021.
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.