Starbucks' Stock Price Serves Up a Buying Opportunity
A shot of Starbucks shares could boost portfolios as rewards program drives growth.
Next time you’re at Starbucks (SBUX) waiting for that $5.25 double-shot venti caramel macchiato, you might consider spending your money on what may be a better bargain: a tall order of the company’s stock.
A punishing blend of pandemic-related forces has pushed the stock of the world’s largest premium coffee seller down to levels last seen during the fall of 2020 when lockdown restrictions were still in force. That turned out to be a great time to scoop up shares, as they rose to a record high of $126.32 less than a year later when the world started to reopen following the pandemic’s first wave.
Now investors are presented with another buying opportunity. Starbucks shares closed at $90.03 Friday, that’s up from their 52-week low of $87.24 on Feb. 24, the day Russia invaded Ukraine, but down nearly 23% year to date and 14% year over year.
Its P/E of 28.2 times 2021 earnings is markedly below its three-year historical median of 30.6 and five-year of 31.1 times. Adding some investment protection is the company’s annual dividend of $1.96 a share, yielding 2.17%. That compares with the S&P 500’s dividend yield of 1.38%
With the second wave of the pandemic receding and the world learning to cope with COVID, Starbucks is again poised for gains. Consumer spending remains strong, international expansion continues, particularly in China, and the company is pushing ahead with new product introductions. In January, Starbucks launched a line of drinks--Baya Energy--in partnership with Pepsico (PEP) that is available at grocery and convenience stores. The energy drink market is growing at a compounded annual growth rate of 7% a year, and is expected to reach $86 billion by 2026. Moreover, the Starbucks Rewards program is a powerful business within a business that shows no sign of let up.
Morningstar analyst Sean Dunlop puts a fair value estimate on Starbucks of $106 per share. That is an 18% gain from current levels, based on a forward price/earnings of 33 times, and enterprise value/forward of earnings before interest, taxes, depreciation and amortization, or EBITDA, of 20 times. Dunlop expects near-term margin pressures to ease as Starbucks’ wide moat advantages help bolster its dominant position in the global coffee industry, expanding to 59,000 stores worldwide by 2031 from today’s 34,317 and leveraging its powerful brand cache to manage costs.
“It’s a rare growth-at-scale story,” Dunlop says. ``Investors are over-discounting near-term pressures.”
Revenue Rises on Customer Traffic, Rewards Program
Fiscal first-quarter revenue at the coffee chain rose 19% to top $8 billion as global same-store sales gained 13%. In the U.S., first-quarter revenue rose 23% year-over-year to $5.3 billion, spurred by a double-digit increase in customer traffic as Starbucks continues to widen its appeal throughout the day by offering a range of different food and drink options and targeting them to its most loyal patrons.
Those regular customers are a significant plus for the company. Activations and reloads on Starbucks Cards exceeded $3 billion in the quarter and its Starbucks Rewards program increased membership by 21% to a record 26.4 million 90-day active members. Starbucks Rewards represents 53% of total revenue.
“They have the best rewards program in the industry,” says Morningstar’s Dunlop, noting rewards members spend two to three times more than other customers, frequently visit the stores, and are a valuable source of customer behavior data.
Starbucks uses artificial intelligence and machine learning to win customer loyalty by tracking their preferences, providing free birthday rewards, as well as free add-ons, and refills for coffee and tea. The rewards program also benefits the grocery chains and retailers that it partners with to distribute its packaged coffee by boosting customer foot traffic as members earn points when they purchase coffee and other Starbucks products through the outlets. If Starbucks does well, the retailers do, too.
The company, Dunlop adds, has had meaningful sales traction the past few quarters as consumer demand stayed strong despite product price hikes in October and more recently in January. “We’re not seeing demand elasticity,” Dunlop explains. Indeed, in discussing first-quarter earnings, chief executive Kevin Johnson said the company has “additional pricing actions planned through the balance of this year, which play an important role to mitigate cost pressures, including inflation, as we position our business for the future.''
China Sales Down, U.S. Costs Up
Despite delivering record revenue growth in the recent fiscal first quarter ended Jan. 2, Starbucks’ earnings and margins took a hit from the unexpected resurgence of Covid that spread around the world late last year, leading to higher expenses and more severe operational disruptions in its two main markets, the U.S. and China. The company considers the pressures to be temporary and is addressing the higher costs by continuing to raise prices and cutting back spending on marketing, especially as consumer demand remains strong.
Another problem: headline risk from union organizing efforts. In the past six months, workers at more than 100 locations, out of around 9,000 stores in the U.S., filed to hold union elections, and three have voted to unionize. The actions come despite wide recognition that Starbucks pay scales are higher than the industry average and that it provides generous benefits, including college tuition.
In China, where Starbucks has been expanding aggressively and now has more than 5,500 stores, the country’s zero-COVID policy and mobility restrictions led to a “significant” disruption in store hours and transaction volumes, hurting sales and profitability. Store closures and reduced operations at three-quarters of its stores in China led to a 10% decline in same-store sales growth. Responding to the restrictions, Starbucks upped its delivery and online services by partnering with Meituan, China’s biggest food delivery platform. Members of Starbucks Rewards in China, which contributes 75% of sales, receive the same benefits using the Meituan app.
In the U.S., staffing shortages at third-party delivery providers along its supply chain required Starbucks to seek alternative, and more expensive, distribution solutions to meet strong consumer demand. Covid-related worker benefits, including self-isolation pay, vaccine shot paid leave, vaccine side-effect pay, and temporary Covid-19 paid sick days, were “significantly higher” than expected and further eroded margins. Costs to train new employees rose well above historical levels amid high worker turnover.
In addition, to attract and retain workers amid a severe industrywide labor shortage, Starbucks hiked wages to an average of $17 an hour, with a minimum wage of $15. In some markets, workers will earn as much as $23 an hour. Employees with two or more years of service will qualify for a 5% raise in 2022, and those with five or more years a 10% raise. For perspective, Starbucks’ pay scale is already 25% higher than the median average in the restaurant industry.
The cost squeeze, while considered temporary, is expected to continue through the year. In reporting first-quarter results in early February, the company forecast gross margin of about 16.5% in fiscal 2022, down from its historical levels of 18% to 19%, and said fiscal 2022 earnings per share will decline by 4% to 6% from the previous year. Reflecting that margin pain and lowered outlook, it’s the worst-performing stock among its industry peers--including McDonald’s (MCD), Chipotle Mexican Grill (CMG), and Darden Restaurants (DRI)--for the three-month period.
Union Organizing Efforts Spread Nationally
Despite its comparatively generous wage and benefits package Starbucks finds itself confronting the reputational risk of an unprecedented labor uprising as baristas, or “partners” as they are referred to internally. Certain stores have successfully waged union organizing campaigns with workers at two locations in Buffalo and one in Mesa, Arizona, voted to unionize. Workers at three more stores in Buffalo, and locations in Boston, Chicago, and Seattle are also scheduled to hold votes in the coming months.
The actions are being encouraged by U.S. Sen. Bernie Sanders, I-Vermont, who has been egging on union organizers at Starbucks and other companies such as Amazon (AMZN) and Hershey (HSY) via his website, Twitter feed, and other social media platforms. Those organizing efforts have been challenged by Starbucks’ management on a store-by-store basis. That’s an expensive endeavor and has led some big institutional investors focused on environmental, social, and governance issues, such as Trillium Asset Management and Parnassus Investments, to urge Starbucks to reconsider. They want the company to adopt a neutral stance that respects the rights of workers to organize.
Starbucks isn’t alone in seeing increased union activism and whatever happens will have implications for the restaurant industry as a whole.
Meanwhile, Starbucks customers will likely still queue up for their favorite frappuccinos and cold brews. And investors can rely on the long-term “double-digit earnings growth” the company expects.
Sandy Ward does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.