5 Reasons to Stick With the Rebound in Starbucks Stock

In the middle of March 2020, Starbucks (NASDAQ:SBUX) looked doomed. The company was closing stores across America as the novel coronavirus pandemic started to spread like wildfire in the company’s core market. The stores that remained open were limited to drive-thru orders and were stung by significant traffic declines. Worse yet, there was no end in sight to the pandemic, Starbucks’ financial woes, or SBUX stock declines.

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For all intents and purposes, it looked like the end of the world. And Starbucks stock reflected that reality. From Jan. 23 to March 23, Starbucks stock dropped from $95 to $50.

Since March 23, things are have turned for the better. The coronavirus pandemic has started to slow, with new cases plateauing and even declining in major urban areas. Starbucks stores in China have started to re-open. Huge doses of fiscal and monetary stimulus have been poured into the economy.

In other words, we can finally see a light at the end of this tunnel, and the government has given the U.S. economy a lifeboat to make it to the other side. In response, Starbucks stock jumped from $50 to $75.

While the best of this rally has already come and gone, I think SBUX stock is going to keep heading higher for five big reasons:

  1. China store operations will normalize in the second and third quarters of 2020.
  2. U.S. operations will get whacked in the second quarter before more normalizing in the back-half of 2020.
  3. The company has sufficient liquidity to weather a sharp downturn in U.S. operations over the next few months.
  4. Fiscal 2021 numbers will be really good.
  5. SBUX stock remains undervalued.

SBUX Stock Looking Better As China Rebounds

China has been reporting near-zero transmission of the coronavirus for several weeks now. As a result, China has gradually re-opened its economy. Employees are back at work. Stores and shops are open. Consumers are out in the world, spending money.

Starbucks’ recent second quarter update affirms that this rebound in China’s economy is corresponding to a rebound in Starbucks’ China business.

Around 95% of the company’s China stores are now open. They are operating at reduced hours with restricted traffic caps. Still, they are open. And because they are open, traffic trends are rebounding. Comparable sales growth dropped as low 90% in mid-February. Sales trends have gradually recovered since then. In the last week of March, comparable store sales declined by “just” 42%, representing the seventh consecutive week of sequential improvement.

Management expects economic normalization in China to continue and for comparable sales growth trends to keep recovering. Within two quarters, management believes its China stores will be back to normal.

The consistent comparable sales trend improvement in China over the next six months will provide firepower for Starbucks stock to keep rallying.

U.S. Will Rebound Soon

The U.S. is behind China in terms of coronavirus developments. While China is already in the recovery stage, the U.S. is in the “flattening of the curve” stage.

Consequently, the U.S. economy remains largely shut down, a lot of Starbucks’ U.S. stores remain drive-in only, and Starbucks U.S. comparable store sales dropped by 60% to 70% in the last week of March.

But the coronavirus is progressing much in the same way it progressed in the U.S. That puts the U.S. in the recovery stage by May or June.

Once that happens, Starbucks U.S. comparable sales trends will start to improve, much in the same way they are already improving in China. Assuming a similar time-line (about six months), then Starbucks U.S. stores should be back to normal by the end of the year.

Rebounding U.S. comparable sales trends from April into December will help carry Starbucks stock higher.

Strong Balance Sheet

Starbucks has ample liquidity to weather a sharp downturn in U.S. operations over the next three to six months, without risking insolvency or putting too much pressure on the balance sheet.

The company recently reported that they had $2.5 billion in cash and equivalents on the balance sheet. Coupled with $3.5 billion in short-term borrowing facilities, this gives Starbucks more than enough cash on hand to absorb significant losses over the next one to two quarters.

It’s also worth mentioning that Starbucks is not in a zero-revenue situation like cruise line operators. Instead, 58% of Starbucks stores are drive-thru locations. About three-fourths of those drive-thru locations are still open. Yes, they are operating at reduced hours, with reduced traffic.

However, they are still generating revenue. This revenue generation will help alleviate cash burn over the next several months.

Fiscal 2021 Will Be Good for SBUX Stock

Long-term investors should forget about fiscal 2020 numbers. They won’t be good. And they won’t be good because of a “Black Swan” pandemic.

Instead, investors should focus on more normalized fiscal 2021 numbers. Those numbers should be quite good.

By fiscal 2021, the coronavirus pandemic should largely be in the rear-view mirror and the economy will be in a good position. That’s because companies are presently sitting on record amounts of cash, with borrowing and spending costs as low as they’ve ever been. Thus, once the coronavirus pandemic passes, U.S. corporations will have tons of cash to spend, and plenty of incentive to spend that cash.

As capital spending picks up, labor markets will improve. Consumers will have jobs again. Those jobs, coupled with pent-up demand from being stuck inside, should propel robust consumer discretionary spending.

As consumer discretionary spending rebounds big next year, Starbucks numbers could go from being really bad in 2020, to really good in 2021.

Starbucks Stock Is Undervalued

Zooming out, Starbucks is still the world’s number one retail coffee chain with a long history of outstanding growth, and a long runway ahead for even more growth through international unit expansion, delivery, and digital business vertical development.

At $75, Starbucks stock is still cheap considering those long-term growth prospects.

After taking into account coronavirus-related disruption, I now see Starbucks earning less than $2 per share in 2020 (versus management’s previous guide calling for over $3). However, my long-term estimates on Starbucks remain little changed, based on the assumption that coronavirus-related disruption is constricted to fiscal 2020, and the company’s growth tailwinds in retail coffee consumption persist over the next several years.

Consequently, I still see Starbucks earning somewhere around $5.50 per share by fiscal 2025. Based on a 22.5-times exit multiple — which is a trailing five-year average valuation for restaurant stocks — and a 10% annual discount rate, that implies a 2020 price target for Starbucks stock of nearly $85.

Bottom Line on SBUX Stock

Starbucks stock is a long-term winner that is going through a near-term rough patch. However, the storm is passing, and the skies are starting to clear up. They will continue to clear up over the next few quarters. As they do, Starbucks’ growth trends will continue to improve, and Starbucks stock will keep rebounding.

Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he was long SBUX. 

Article printed from InvestorPlace Media, https://investorplace.com/2020/04/5-reasons-to-stick-with-the-rebound-in-sbux-stock/.

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