Starbucks: Ignore Analysts' Price Targets And Wait To Buy

| About: Starbucks Corporation (SBUX)

Summary

When a company’s shares trade at premium levels, news that appears to be good news for investors turns out to be “bad news” for investors.

The company’s shares sold off on apparently good earnings news, but the sell-off was due to the company’s premium priced shares, not the earnings news.

Ignore any analyst recommendation for the company’s shares with a price target based on a forward price to earnings ratio over 30.

While the company has a bright future, it has made missteps recently, including closing its Teavana tea bars and all of its La Boulange pastry cafes.

The company’s shares, purchased at a more value-oriented price, will reward investors with annual dividend increases and share price appreciation as its initiatives continue to unfold.

Starbucks' (NASDAQ:SBUX) shares have made an extraordinary run since its darker days in 2008-09, when Howard Schultz returned to the company to repair the damage to the company that came from a strategy of overexpansion without fully understanding the adverse effects of such strategy. In other words, expansion without a conscious effort to control quality and a brand's image leads to the dilution of the product quality and the brand. With the company's turnaround in place, the company's shares are now trading at premium levels. When a company's shares trade at premium levels, news that appears to be good news for individual investors turns out to be "bad news" for larger institutional investors. A sell-off on apparently good news is what is happening now to SBUX shares. In reaction to the company's fiscal first quarter 2016 results, investors reacted negatively to SBUX's weaker-than-expected second-quarter 2016 earnings guidance and the lack of an increase in its full-year 2016 outlook, following better-than-expected first quarter results. SBUX announced adjusted earnings per share of 46 cents, a 15 percent increase from the year-ago quarter due to strong revenue growth. Adverse currency effects depressed revenue by 2 percent and adjusted earnings by 5 percent. The company recorded revenue of $5.37 billion, a 12 percent increase from the year-ago quarter due to strong holiday sales. Same-store sales increased by 8 percent due to increased traffic trends. Adjusted operating margins increased to 19.9 percent as an increase in sales leverage and cost of goods sold offset increased employee and digital investment costs. SBUX's Americas division recorded net revenue that increased 11 percent from the year-ago quarter to $3.73 billion due to food and beverage innovation and accelerated card loads and strong gift card sales. Food sales increased 20 percent from the year-ago quarter due to strong performance of breakfast sandwiches and lunch offerings. New beverages and strong core beverage performance drove beverage revenue growth.

Do not get us wrong about our belief in the company. We believe that the company's shares should be a consideration for all investors when they have the opportunity to invest in the company's shares at a more value-oriented price. SBUX shares, however, do not represent value now. Despite our belief that SBUX shares are expensive right now, we continue to read about analysts with ever-higher price targets for SBUX shares. Be careful about listening to such analysts. As our readers know and has been noted by other commentators (see Barrons' trader column this week--subscription required), mainstream analysts tend to be excellent contrary indicators if you are wise to how they operate with their "buy high-sell low" mentality. Use their opinions to your advantage for contrarian purposes but by all means do not listen to their buy and sell recommendations. For example, recently a bullish SBUX analyst initiated coverage on the stock with a $70 target price, stating that the company's digital initiatives such as mobile ordering would help sustain same-store sales momentum. The analyst went on to provide their basis for their rating for SBUX shares, but the most outrageous portion of the analysis would be its numerical support for the target price. The analyst saw SBUX "earning $1.90 a share during fiscal 2016 and another $2.19 a share [in fiscal 2017]." The analyst indicated their current price target valued SBUX at 37 times fiscal 2016 earnings per share estimates [and at about 32 times 2017 fiscal earnings estimates] and such analyst expects 18 percent average annual growth for the company over the next five years. In our opinion, such an analyst recommendation and price target are reckless and potentially damaging to individual investors who follow it. There is no way an individual investor should listen to an analyst with a price target based on a forward price to earnings ratio ranging from 32 to 37 for a company the size of SBUX. For an individual to listen to such a recommendation is potentially damaging to a portfolio for multiple years if such investor listens to such advice and purchases SBUX shares at or near a multi-year high and the company ultimately underperforms such analyst's estimates. While SBUX has a lot going for it, remember that the company can and has made missteps recently including: 1) closing its Teavana "tea bars" that served made-to-order tea drinks and food items; and 2) closing all its La Boulange pastry cafes. (SBUX has since incorporated both the Teavana and La Boulange brands onto the menus of its coffee stores.) With this in mind, we recommend that potential investors in SBUX shares put the company's shares on their watch list and wait for a more opportune price entry target.

Our View

SBUX continues to deliver outstanding quarterly results, but in the company's most recent quarterly guidance was "disappointing." In our opinion, investors considered the company's guidance as disappointing given that the company's shares trade at a high relative price to earnings ratio. Of course, the company's prospects remain bright over the intermediate and long term given: 1) its strong execution of multiple initiatives in the U.S., 2) its strong potential to become an international brand, 3) its impressive loyalty programs and digital offerings, and 4) its long-term potential for growth in the consumer products market both in the U.S. and internationally. Risks to the company's performance, however, will remain for the company along the way as it grows around the world. Such risks include "input" costs to its business such as coffee beans, milk and sugar costs. SBUX addresses, in part, rising commodity costs in advance through its commodity hedging strategies. Even with hedging strategies, there are times where SBUX has to raise prices. Additional risks for SBUX are market saturation and economic hardships in its various markets. SBUX could also be at risk by overextending itself from time to time with their many initiatives (as noted above in regard to the company's Teavana tea bars) and losing focus on its core competencies. We believe, however, that over the long term while SBUX faces many risks, ultimately only SBUX's management can hurt SBUX through failure to effectively anticipate and address current and anticipated economic, commodity and competitive risks.

Earnings estimates for SBUX's 2016 fiscal year is $1.89 and for 2017 fiscal year is $2.19. At SBUX's current price, their forward price-to-earnings ratio is 30.50 based on the company's estimated earnings for fiscal year 2016 and 26.30 based on earnings estimates for fiscal year 2017. In the most recent five years, the price to earnings ratio for SBUX shares has ranged from about 23 to 35 (excluding charges). In addition, SBUX has an excellent dividend growth history that is likely to continue. SBUX continues to be an iconic global brand with coffee shops that provide its famous "third place" experience to provide relief and certainty for their customers from a chaotic and unpredictable world. Further, SBUX continues to be a leader in the use of social media to attract and retain its customers. Ultimately, it is likely that the company's mobile order/pay application, delivery services and third-party loyalty partnerships, innovative food and beverage offerings, lunch and evening programs, Starbucks Reserve premium coffees and Teavana teas should drive revenue and profit growth in the intermediate and long term. While we believe SBUX has a very bright future ahead of it, however, we repeat our belief that the company's shares have become expensive near term. As such, we would like to see the current price drop to the $44.50 to $48.50 price range (a price-to-earnings ratio ranging from about 20 to about 22 based on fiscal year 2017 projected earnings of $2.19) before potential investors buy the company's shares. Our buy target may be a bit aggressive, but it should serve as a guidepost for potential investors waiting for a better entry price to invest in SBUX shares. For now, we say ignore any analysts with price targets for SBUX based on forward price to earnings ratios of 30 or more and wait for a better entry price.

Disclosure: I am/we are long SBUX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.