Starbucks (NASDAQ:SBUX) is back in the black. After a decline that reached over 40% at March lows, Starbucks stock now is up 3% so far in 2020.
To some investors, the rally might not make much sense. After all, Starbucks has taken a big hit from the novel coronavirus pandemic, which closed stores worldwide and pressured traffic. There are long-term concerns as well.
But I’m not one of those investors. Indeed, I’ve recommended Starbucks stock since those dark days in March, and I’m not backing off that call now. Starbucks remains one of the world’s great consumer companies, and there’s simply a lot to like when it comes to SBUX stock.
With fiscal fourth quarter earnings arriving on Thursday morning, I expect more investors will come around to the long-term bull case here. And that means the rally in Starbucks stock likely is closer to the beginning than to the end.
The Case Against Starbucks Stock
Despite the big rally from March lows, Starbucks stock hasn’t had a great 2020. In fact, the stock has modestly underperformed the S&P 500.
There are reasons why an investor would expect that to be the case. Again, Starbucks took a hit from the pandemic. Stores were closed in China, the U.S., and Europe. Traffic has been weak even as locations have reopened. Revenue in the fiscal third quarter (which ended June 28) declined 38% year-over-year. Starbucks posted a significant operating loss in the quarter, even on an adjusted basis.
The worries aren’t just short-term, either. “Work from home” seems like a significant long-term effect of the pandemic. Presumably, some consumers that stopped at Starbucks on their way to (or from) the office no longer will do so.
Then there’s valuation. Starbucks stock trades at 33x forward earnings. That’s an above-market multiple for a stock that seems to have a few very real risks.
Surely, the rally in SBUX has to be near an end, right?
Taking the Long View
Not so fast.
The concerns are real, but to some extent overblown. Yes, Starbucks is taking a near-term hit to profitability. But stocks aren’t valued solely on what they’re doing this year. Investors need to take the long view, and this pandemic will pass. Starbucks will return to its previous growth trajectory.
And that trajectory remains impressive. Starbucks probably is at or near saturation in the U.S. But it still has a massive opportunity in China, where its footprint and reach is only growing. Other markets in Asia and Europe offer room for expansion as well.
As for the long-term effect of “work from home,” there was an intriguing nugget buried in the third quarter earnings release. Revenue for the quarter did decline 38% year-over-year, with a 40% plunge in same-store sales. But the number of members in Starbucks’ loyalty program who had been active in the preceding 90 days was down just 5%.
Those loyalty members obviously are Starbucks’ most consistent and likely most profitable customers. And it appears that most of those customers came back relatively quickly.
So the concerns here seem manageable. Again, this is a company that has proved its greatness. I believe it will be able to manage through this unprecedented period, and beyond.
If that’s the case, the valuation assigned Starbucks stock is just fine. In fact, it’s likely attractive. After all, that 33x multiple is on earnings that are probably depressed to at least some extent by lingering effects of the pandemic. And history suggests Wall Street, as often has been the case, probably is underestimating Starbucks’ earnings power.
For this business, from a long-term perspective, 33x earnings seems like a fine multiple to pay.
A Buy Ahead of Earnings
I fully expect that fourth quarter earnings on Thursday morning will only help the case.
To be sure, Starbucks’ results aren’t going to bounce back instantly. But we no doubt will see substantial improvement relative to the Q3 print. I’m particularly interested in seeing how high loyalty penetration reaches. If that number turns positive, as it might, then it’s clear that Starbucks is on track for a recovery.
As far as revenue goes, Wall Street expects a 10% decline. That alone would be a noted improvement from Q2 levels. But it’s also a figure that leaves room for Starbucks to top expectations. Its history suggests that it will do so.
And if Starbucks can post that kind of quarter, the narrative here probably changes for good. As long as results are getting back to normal, investors will put the pressures of 2020 in the rearview mirror — and start looking to 2021 and beyond. Given Starbucks’ potential, that view should be rosy indeed.
On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.