Given the tough challenges that Starbucks (NASDAQ: SBUX) faces, SBUX stock looks meaningfully overvalued at this point.
The Recession and Social Distancing
One obvious headwind that Starbucks has to cope with is the recession. Although, as I’ve pointed out previously, the vast majority of high-income individuals have kept their positions during this downtrend, the coffee retailer will lose some sales due to the economic downturn.
Credit ratings agency Fitch recently cut its grade on the company’s debt to BBB from BBB+ and placed a “Negative” outlook on the company, down from “Stable.” As reasons for the downgrades, the firm cited the company’s recent issuance of $3 billion of new debt and “the significant business interruption from the coronavirus pandemic and the implications of a downturn in discretionary spending that … [it] expects could extend well into 2021.” Fitch predicts that the company’s revenue will sink about 14% this year, while its EBITDA will tumble a massive 60%.
And as I noted in a prior column, I expect the company to be disproportionately hurt by social distancing. Starbucks CEO Kevin Johnson made me feel better about this issue, however, when he said that “over 80% of … [its U.S.] customer occasions before the crisis were on-the-go.”
Still, many of the company’s customers are probably more likely to order food and more than one drink when they spend a long time in its stores with one or more companions. Therefore, the company may generate much more than 20% of its revenue from customers who drink its beverages in its stores.
China and Other Ramifications of the Pandemic
In China, the impact of the economic downturn on the company’s results is likely to be stronger than in the U.S. That’s because Starbucks’ drinks are actually much more expensive in the Asian country than in the U.S., even though China’s salaries are much lower. With China’s economy likely to grow just 1% in 2020, the weakest increase since 1976, it’s clear that many Chinese citizens are going to cut back on the amount they spend on Starbucks’ drinks, which are an extravagant luxury in the country. Likely to exacerbate that trend, as I’ve pointed out in the past, is the rising anti-American sentiment in China.
All of this will impact SBUX stock to some degree. Indeed, even though the nation had “largely returned to work” in April and almost all of the company’s stores were open in the country by the end of the month, Starbucks’ sales in China for the month “were down approximately 35%.” Given all of the problems that the company faces in China, I think its forecast for its sales in the country to be “trending toward roughly flat by the end of Q4 relative to the prior year” will prove to be way too optimistic.
Meanwhile, beyond social distancing, the response to the pandemic will hurt Starbucks and SBUX stock in multiple other ways.
The work-from-home trend will not be positive for Starbucks, which thrives on consumers getting coffee on the way to work or during their lunch breaks. Similarly, with many brick-and-mortar retailers likely to go bankrupt, the closures of hundreds, if not thousands, of brick-and-mortar stores are going to have a meaningful, negative impact on Starbucks’ results. That’s because many people like to buy coffee from Starbucks before or after shopping.
Valuation and the Bottom Line on SBUX Stock
Despite all of these negative catalysts, the shares have fallen just 16% this year and just 5% over the last 12 months. The company’s forward price-earnings ratio stands at 47, which is very high, given the many challenges it is facing this year and beyond.
Specifically, although the social distancing issues will recede if or when a vaccine is found or when herd immunity is achieved, many of the other issues will linger for a long time. Among these are the work-at-home trend, U.S.-China animosity, the weaker Chinese economy and fewer brick-and-mortar stores. Given these points, I would recommend that medium-term and long-term investors sell SBUX stock.
Larry Ramer has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been Lyft, solar stocks, and Snap. You can reach him on StockTwits at @larryramer. As of this writing, he did not own shares of any of the aforementioned stocks.