Next time you’re at Starbucks (SBUX) If you’re waiting for that $5.25 double-shot Venti Caramel Macchiato, consider spending your money on something that might be a better bargain: a big order of the company’s stock.
A punitive mix of pandemic-related forces has pushed shares of the world’s largest premium coffee seller to levels last seen in fall 2020, when lockdown restrictions were still in place. This turned out to be a great time to buy stocks as they surged to a record high of $126.32 less than a year later as the world started to reopen after the first wave of the pandemic.
Now investors have another buying opportunity. Starbucks shares closed at $90.03 on Friday, up from its 52-week low of $87.24 on Feb. 24, the day Russia invaded Ukraine, but up nearly 23 year-to-date % and down 14% year-on-year.
Its P/E ratio of 28.2 times 2021 is well below its historical three-year median of 30.6 and its five-year median of 31.1. For some investment protection, the company’s annual dividend of $1.96 per share translates into a yield of 2.17%. This compares to the S&P 500’s dividend yield of 1.38%.
As the second wave of the pandemic recedes and the world learns to cope with Covid, Starbucks is poised for profit again. Consumer spending remains strong, international expansion continues, particularly in China, and the company is driving new product launches. In January, Starbucks partnered with Pepsico to launch a line of beverages — Baya Energy (PEP) which is available in grocery and convenience stores. The energy drink market is growing at a CAGR of 7% per year and is expected to reach $86 billion by 2026. Additionally, the Starbucks Rewards program is a strong business within a business that shows no signs of slowing down.
Morningstar analyst Sean Dunlop estimates Starbucks’ fair value at $106 per share. That’s an 18% gain from current levels, based on 33 times forward price/earnings and 20 times enterprise value/forward earnings before interest, taxes, depreciation and amortization, or EBITDA. Dunlop expects pressure on margins to ease in the near term as Starbucks’ wide-ranging benefits help strengthen its dominant position in the global coffee industry, expanding from 34,317 today to 59,000 stores worldwide by 2031 and its strong brand cache use to control costs.
“It’s a rare story of growth at scale,” says Dunlop. “Investors are discounting short-term pressures too much.”
Revenue increases through customer traffic, rewards program
The coffee chain’s fiscal first-quarter sales rose 19% to more than $8 billion, while global same-store sales rose 13%. In the U.S., first-quarter sales rose 23% year over year to $5.3 billion, driven by a double-digit increase in footfall as Starbucks continues to expand its appeal throughout the day by offering a range of different foods and drinks and addresses them to his most loyal patrons.
These regular customers are a big plus for the company. Activations and top-ups on Starbucks cards exceeded $3 billion for the quarter, and the Starbucks Rewards program grew membership by 21% to a record 26.4 million 90-day active members. Starbucks Rewards accounts for 53% of total sales.
“They have the best rewards program in the business,” says Morningstar’s Dunlop, noting that rewards members spend two to three times more than other customers, frequent in-store visits, and are a valuable source of customer behavior data.
Starbucks uses artificial intelligence and machine learning to earn customer loyalty by tracking their preferences, offering free birthday rewards, and free coffee and tea add-ons and refills. The rewards program also benefits the grocery chains and retailers it partners with to distribute its packaged coffee by increasing footfall as members earn points when they purchase coffee and other Starbucks products through its outlets. When Starbucks is doing well, retailers are doing well too.
The company, Dunlop adds, has delivered a significant sales boost in recent quarters as consumer demand has remained strong despite product price increases in October and most recently in January. “We don’t see demand elasticity,” explains Dunlop. Indeed, while discussing first-quarter results, Chief Executive Kevin Johnson said the company has “additional pricing measures planned for the remainder of this year, which will play an important role in mitigating cost pressures, including inflation, as we continue our… Positioning business for the future.”
Sales in China down, costs up in the US
Despite record sales growth in its most recent fiscal first quarter, which ended Jan. 2, Starbucks’ profits and margins were hit by the unexpected resurgence of Covid, which spread globally late last year and resulted in higher spending and more severe operational disruptions in two key markets, the United States and China. The company sees the pressure as temporary and is addressing the higher costs by continuing to raise prices and reducing marketing spend, 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 at approximately 9,000 stores across the US have petitioned for union elections to be held, and three have voted for a union. The moves come despite widespread acknowledgment that Starbucks’ pay scales are above industry averages and offer generous benefits, including tuition.
In China, where Starbucks has expanded aggressively and now has more than 5,500 stores, the country’s zero-Covid policy and mobility restrictions resulted in “significant” disruption to store hours and transaction volume, hurting sales and profitability. Store closures and operational restrictions in three quarters of stores in China led to a 10% decline in same-store sales growth. In response to the restrictions, Starbucks enhanced its delivery and online services through a partnership with Meituan, China’s largest grocery delivery platform. Starbucks Rewards members in China, which contributes 75% of sales, get the same benefits with the Meituan app.
In the US, staffing shortages at third-party suppliers along its supply chain have forced Starbucks to look for alternative and more expensive distribution solutions to meet strong consumer demand. Covid-related employee benefits, including pay for self-isolation, paid vacation for vaccination shots, pay for vaccine side effects and temporary paid sick leave from Covid-19, were “significantly higher” than expected, further eating into margins. The cost of training new employees rose well above historical levels given high employee turnover.
Additionally, Starbucks has raised wages to an average of $17 an hour with a $15 minimum wage to attract and retain workers amid a severe industry-wide labor shortage. In some markets, workers earn up to $23 an hour. Employees with two or more years of service will receive a 5% salary increase in 2022, employees with five years or more will receive a 10% salary increase. For comparison, Starbucks’ pay scale is already 25% above the median average in the restaurant industry.
Cost pressures, while seen as temporary, are expected to continue throughout the year. When it released its first-quarter results in early February, the company forecast a gross margin of about 16.5% for fiscal 2022, down from historical levels of 18% to 19%, and said earnings per share for fiscal 2022 would be up 4% to 6% will decrease. from the previous year. Given 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 a period of three months.
Union organizing efforts are spreading across the country
Despite its comparatively generous salary and benefits package, Starbucks faces the reputational risk of an unprecedented worker uprising as baristas, or “partners,” as they’re known internally. Certain stores have successfully conducted union organizing campaigns with workers at two locations in Buffalo and one in Mesa, Arizona, who voted to unionize. Workers at three other stores in Buffalo and at locations in Boston, Chicago and Seattle are also scheduled to hold votes in the coming months.
The actions are being promoted by US Senator Bernie Sanders, I-Vermont, who is goading union organizers at Starbucks and other companies like Amazon (AMZN) and Hershey (HRCR) through its website, Twitter feed and other social media platforms. These organizational efforts were challenged by Starbucks management from store to store. It’s an expensive proposition and has prompted some big ESG institutional investors like Trillium Asset Management and Parnassus Investments to urge Starbucks to reconsider. They want the company to take a neutral stance that respects workers’ right to organize.
Starbucks isn’t alone in seeing increased union activism, and whatever happens will impact the restaurant industry as a whole.
In the meantime, Starbucks customers will likely still be lining up for their favorite frappuccinos and cold beers. And investors can bet on the company’s promised long-term “double-digit earnings growth.”