With shares in Starbucks (NYSE: SBUX) having underperformed the S&P 500 since the start of the year, many investors may be wondering what the company has to do to record strong share price performance. After all, Starbucks' Q2 update was extremely positive, with global comparable store sales rising by 6% and operating income increasing by 11% versus the same quarter of the previous year. However, investor sentiment has weakened year-to-date despite this.
Clearly, this may be somewhat concerning for investors in Starbucks, but we think that it presents an excellent entry point. In fact, we believe that Starbucks has the scope to deliver improved financial performance as well as a rising share price that beats the S&P 500 moving forward. Following are the key catalysts which we think will have a positive impact on Starbucks' top and bottom lines, as well as on investor sentiment and its share price performance.
With Starbucks having a growing exposure to the emerging world, we think that it is set to tap into a stunning growth engine which will have a positive impact on its profitability and share price. For example, in Q2 it increased transactions in China by 5% and revenue in the world's second largest economy by 18%. This highlights the scale of the opportunity on offer for Starbucks in China, with its high degree of brand awareness among consumers providing the perfect environment through which to grow its brand and develop customer loyalty.
With incomes in China set to rapidly rise so that 75% of people living in cities are earning between $9,000 and $34,000 per annum within the next six years, the potential for affordable consumer goods such as Starbucks' coffee is huge in our opinion. We think that China's per capita incomes will continue to increase because of the strength of the Chinese economy as it successfully transitions toward being increasingly consumer-focused. This should open up opportunities for growth within the consumer goods space and provide for greater job opportunities - particularly in urban areas which should have a positive impact on per capita incomes in our view.
And with Starbucks setting itself a target to open 900 new stores in China and across the Asia Pacific region in the current year alone, we think that Starbucks' emerging market exposure has the potential to be a major catalyst on its share price moving forward.
Looking further ahead, Starbucks' plan to open 500 stores per year over the next five years in China shows that it has a long-term view on the country's economic growth potential. With Starbucks having been in China for 17 years, it is starting to get the morning-day part, where it is educating local people to drink coffee in the morning. It is also perfectly positioned in our view to withstand a downturn in China's economy as it transitions toward a more consumer-focused economy. That's because Starbucks is an affordable luxury which we think people will not give up in times of hardship. As such, Starbucks' sales could be a lot more resilient than many investors currently believe.
Additionally, it is estimated that discretionary spending in China will exceed 7% growth per annum between 2010 and 2020. This is a faster rate of growth than spending on consumer staples, which is due to rise by 5% per annum. This shows that China's appetite for discretionary items such as Starbucks' coffee is likely to remain high, with the company's major store opening program able to take full advantage.
Furthermore, Starbucks is expanding its Teavana segment into China in the current fiscal year. With China being the world's biggest consumer of tea and having a retail tea market size of $10 billion in 2014, the opportunities for growth are significant. Starbucks is of the view that Teavana is complementary to its coffee business and we think it will help to develop further growth in the company's earnings and share price moving forward, as well as help Starbucks to capitalize on its aggressive store opening initiative.
In addition, we're bullish about Starbucks' potential in India. Although it only has 100 stores there and growth will be slower than in China due to infrastructure issues, Starbucks believes that it will have as many stores in India over the long run as it will in China. Therefore, over the long run, we think that the dual effects of expansion in China and in India will positively catalyse Starbucks' share price.
Through having a high degree of exposure to non-US markets, we believe that Starbucks will benefit from a positive currency translation moving forward. US interest rate rises are slower than previously anticipated, and although we think they are ahead, we think their pace of increase will be lower than had been priced in by the market in recent months. Brexit further backs up our view regarding interest rate rises, with the UK's decision to exit the EU causing a high degree of volatility in world markets and thereby likely to make the Federal Reserve more dovish. This was seen following the market volatility earlier this year, so we expect interest rate rises to be pushed further back.
As such, the US dollar could weaken and provide Starbucks with a turbo boost to its earnings in the short run, since the company has 46% of its total store numbers located outside of the US, so non-US exposure represents a significant part of its earnings profile.
Of course, we also think that Starbucks has a tremendous opportunity to grow within the US, too. A key reason for that is the customer loyalty which the company currently enjoys, which we believe could allow it to increase pricing at a relatively rapid rate so as to improve margins and profitability. Part of the reason for this is clearly the quality of the Starbucks product and its well-located stores, but we also believe there is an opportunity to engage customers yet further through digital offerings.
For example, Starbucks is focused on increasing its mobile order and pay usage, with it doubling over the last year and Starbucks now processing 8 million mobile order and pay transactions per month. This dovetails neatly with a 16% increase in membership of Starbucks' loyalty program, with there being over 12 million active members in the US alone.
The combination of more customers enrolled on its loyalty program alongside rapid innovation on its mobile ordering platform could lead to an increasingly loyal customer who sees the convenience and ease of ordering as a premium worth paying. Thus, we feel that Starbucks could be able to raise pricing at a rapid rate due to a more price inelastic demand curve. This rise in profitability could act as a positive catalyst on the company's share price.
Despite Starbucks' share price fall since the turn of the year, many investors may feel that the company's valuation is simply too high. For example, Starbucks has a forward P/E of 25.4 while the S&P 500 has a forward P/E of 18. As such, some investors may argue that Starbucks is due a de-rating. However, we feel that Starbucks is worthy of a premium rating and in fact its P/E could move higher. That's because it is forecast to increase its EPS by 12% this year and then by a further 16% in the following financial year.
Alongside its positive catalysts of significant and growing exposure to China and the emerging world, the potential for a turbo boost to earnings from a weakening US dollar and the prospect of higher pricing power from a higher level of customer loyalty and digital engagement, we think that Starbucks' upbeat EPS forecasts mean that now is the perfect time to buy. We think that its shares will rise and beat the S&P 500 moving forward.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.