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October 10, 2017

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Stock Research: Starbucks (NASDAQ: SBUX)

September 18, 2017

Company Background

 

Starbucks (the “Company”) has been a favorite of investors for many years. The coffee behemoth, which IPO’d in 1992, recently celebrated it’s 25th anniversary since its IPO. Starbucks stock has beat the market over the last five and 10-year time frames. In fact, an investor who purchased 100 shares at the initial IPO would have spent $1,700 for a position that’s worth over $350k today! Not surprisingly, the Company’s expansion has been just as fast: between 1998 and 2008, the Company grew from 1,886 stores to 16,680 globally. Today, with over 26,000 stores across 75 countries, the Company services over 90M customers per week and generates revenue of $21.31B annually (2016).

 

Despite its historic growth and subsequent returns, over the last two years, Starbucks stock has dropped -10% (vs. the S&P 500 which is up +26%). After posting its Q2 ‘17 earnings in late April 2017, Starbucks stock rose +5.3% over the subsequent month to $64.57 (as of June 2, 2017). Just one month later, Starbucks stock fell -9.8% to $58.25 (July 2, 2017). And as of September 2017, the stock has been hovering around $54, a further dip since July. While it’s clear that short-term stock performance has been underwhelming, many investors are looking to the Company’s long-term prospects, and potential issues, to determine if it’s a worthwhile investment. Specifically for some investors, the drop in the Company’s stock price is being touted as a potential value play.

 

 

 

 

Issues & Potential Solutions

 

Oversaturation of Locations, Ubiquity and “Basic” Problem

 

Due to ever-increasing store saturation, cannibalization of existing store sales seems to have accelerated over the last several years, which may create challenges in reviving US same store sales momentum and could ultimately result in slower new store development. With concerns that the chain may have too many locations, the dangers of ubiquity could be more serious than ever before. The Company’s once upscale reputation has shifted and continues to lose sophistication, as products like Pumpkin Spice Latte become synonymous with “basic.” This shift in reputation is critical, as ubiquity creates a pull toward becoming “just another fast-food chain,” something the Company will need to avoid if it plans to continue charging $4+ for a latte.

 

To combat this ubiquity problem, the Company is rolling out more upscale Reserve stores and Roasteries. In a recent press release, the Company noted that it’s 15,000-square-foot Roastery in Seattle is a “window into the future of the brand.” The unique store serves a variety of upscale drinks (e.g. a $10 Nitro Cold Brew Float) and is a testament to the Company’s resolve to stay relevant. The Company has announced plans to open Roasteries in Shanghai, New York, Milan, Tokyo, and Chicago, and former CEO Howard Schultz has said there is potential for 20–30 Roasteries globally. In addition, the Company is planning to open Reserve bars inside of thousands of Starbucks locations, “serving small-batch coffee and utilizing a range of more complex brewing methods, like siphon brewing” according to the Company.

 

Same Store Sales Slowdown & International Expansion

 

Same-store sales have been decreasing recently: in Q2 ‘17, the Company posted global same-store sale growth (SSSG) of 3.0%, which was lower than analysts’ estimate of 3.7%. To combat slower growth, the Company is planning to open an average of 2,400 locations per year around the globe through 2021. Of note, approximately 25% of worldwide expansion will come from just one market: China. The Company now has 2,600 stores in 127 Chinese cities, and opens stores at a rate of more than one per day.

The Company expects to double its footprint in China, leading to the possibility of the Chinese market overtaking the US in terms of relevance to the Company. In fact, the Company recently reported that its newest cafes in China are generating the highest sales volumes, profitability and return on investment of any class of stores in its 17-year history there.

 

Lack of Innovative Menu Items

 

In yet other play into a new market, the Company is trying to penetrate the high traffic lunch market with the launch of its “Mercato” lunch program. The program, which was piloted in early 2017 in 100 stores in the Chicago area, showcases salads and sandwiches made fresh daily, with the unsold portions being donated to FoodShare. This expansion plays into the Company’s plans to double their food business by 2021.

 

Congestion in Mobile & in-Store Purchases

Since the roll out of their mobile ordering app, lines and congestion at many Starbucks locations has increased and caused frustrations with consumers. To overcome the problem of congestion at its restaurants and to reduce the waiting period for its customers, Starbucks has implemented a new digital ordering system. This new system has streamlined the ordering and checkout process, allowing for more efficient “express” locations.

 

Future Outlook & Summary

 

Due to the above initiatives, in the next year analysts are expecting Starbucks to hit revenue of approximately $23.8B, indicating an increase of +8% YoY. Growth is expected to be driven by increases in new stores (globally), positive same-store sales growth, and growth in packaged good sales. SSSG, a key indicator for the Company, is expected to be improved by technological advancements, improvements and expansions in menu offerings, and growth in Reserve and Roasteries. These sales increases along with lower commodity prices and lower G&A expenses are expected to drive margin improvements, partially offset by a rise in labor costs.

 

Many of the initiatives outlined above have increased the company’s expenditures. These major initiatives are how the Company plans to boost earnings per share at +15% to +20% during the next five years. However, if these new implemented changes fail to meet Company revenue expectations, the increased expenses will likely put pressure on the Company’s operating profit and cause issues for the Company’s stock performance.

 

Summary

 

Starbucks stock has under-performed recently due to a variety of both systemic and newly uncovered issues. However, there seem to be some positive signs for the restaurant, including promising investments in key areas of growth. While the Company likely won’t grow at the same pace it has over the past 25 years, the Company still looks positioned to deliver impressive gains that could produce healthy long-term gains for value investors. Of the 34 analysts that follow Starbucks, 82.4% are recommending a “Buy,” and 17.6% are recommending a “Hold.” None of the analysts are recommending a “Sell.”

 

 

Disclosure: I have no positions in Starbucks (SBUX), and have no plans to initiate any positions within the next 72 hours.

 

 

 

 

 

 

 

 

 

 

 

Sources

  • https://www.fool.com/investing/2017/03/18/3-terrible-reasons-to-sell-starbucks-stock.aspx

  • http://www.businessinsider.com/starbucks-oversaturation-and-basic-image-problem-2017-9

  • https://seekingalpha.com/article/4105558-starbucks-still-cheap-53?page=2

  • http://www.marketwatch.com/investing/stock/sbux/analystestimates

  • http://marketrealist.com/2017/07/whats-behind-decline-starbucks-stock-price/

  • http://marketrealist.com/2017/07/whats-behind-decline-starbucks-stock-price/

  • https://www.thestreet.com/slideshow/14109632/1/is-starbucks-making-great-acquisitions-it-sure-doesn-t-seem-like-it.html

  • https://www.zacks.com/stock/news/275641/starbucks-freshens-menu-with-coldpressed-espresso-shot

  • https://seekingalpha.com/article/4104775-starbucks-bargain-around-2-year-lows

  • https://www.qsrmagazine.com/news/starbucks-future-more-mobile-more-food-and-more-china

  • https://www.marketingweek.com/2017/03/23/starbucks-conversational-commerce/

  • https://www.cnbc.com/2017/08/21/coffee-chain-starbucks-is-now-selling-food-trend-sushi-burritos.html

Appendix

 

 

 

 

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