Starbucks Is the Best Opportunity Among Restaurants
Potential catalysts in the pipeline reinforce our fair value estimate, and shares are undervalued.
R.J. Hottovy: We see Starbucks as the most attractive investment opportunity in the restaurant category heading into 2019 as it continues to adjust its stores to better address convenience and experience need states, embrace emergent technologies and platforms to reach consumers outside its stores, and solidify its first-mover advantage in several key geographies around the globe.
In fact, heading into Starbucks' fiscal first quarter 2019, we were looking for three things: One, evidence that the in-store experience, beverage innovation, and digital engagement improvements driving recent U.S. comps had continued; two, an update on the consumer and competitive environment in China; and three, any changes to the algorithm that makes Starbucks one of the more intriguing long-term shareholder return stories in the consumer sector.
With respect to the United States, we've been encouraged by a back-to-basics approach to store operations as well as an automated inventory system--which should allow for greater customer engagement--and a beverage pipeline that should drive increased frequency. Recent sales trends have also been helped by cold beverages, which are helping to improve afternoon daypartm which has been a weakness for the company, but also improving transaction growth. We are also optimistic by several new store layouts that better isolate and address consumers' "convenience and experience" need states.
China remains competitive, but we are optimistic about Starbucks' long-term potential there due to the unique Alibaba partnership that unlocks new growth avenues and the brand's ongoing connection with younger Chinese professionals. Although early, it appears Starbucks in China is benefiting from higher transactions through this delivery partnership, and we expect transaction trends to steadily improve as heavily promotional competitors are forced to raise prices.
Management's ongoing long-term growth algorithm--7% to 9% revenue growth and EPS growth of "at least 10%"--strikes us as reasonable assumptions over the next two years but conservative over a longer horizon due to efforts in the U.S. and China as welk as its Global Coffee partnership with Nestle. We believe shares are undervalued and remain confident in the assumptions underpinning our $74 fair value estimate with several potential catalysts in the pipeline.
R.J. Hottovy does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.