Starbucks (NASDAQ:SBUX) is one of Wall Street's "sweetheart" stocks. The company has been a successful growth story and it should continue to be successful in the long term. Until recently, many thought that while the company had great prospects, much of its future success was already baked in the price of the stock. Could now be a good opportunity to buy Starbucks?
After cutting its guidance and missing analyst estimates, Starbucks lost $4 billion of market value overnight. This is the largest one-day market-value loss in the company's history as a public company. The company announced a slowdown of growth not only in Europe (which became typical for almost every international company around this time), but also in the U.S. Prior to this, it was trading for 30 times its earnings, as investors had a lot of faith in the growth prospects of the company. The company couldn't pinpoint a geographical area, a time or a market as it called its slowdown "a very broad one."
At the quarterly earnings conference, it sounded like the company's management doesn't believe that the slowdown is a problem specific to Starbucks. Recently McDonald's (NYSE:MCD) and Chipotle (NYSE:CMG) also disappointed many investors and this looks more like a macro-economy issue each day.
Recently, Starbucks initiated a new move regarding diversifying its products. The company wants to be much more than a coffee company. It is doing the right things to continue its growth. For example, last month, it acquired Bay Bread LLC in order to be able to offer bakery products and higher quality food to its customers. This move will make Starbucks a direct competitor of Panera Bread (NASDAQ:PNRA) and increase its revenues as customers can buy a larger variety of things from the company's stores.
Even as the company "disappointed" many investors, it posted an earnings growth of 19%. This is another case where the analysts were flying too high and weren't happy with the fact that they were wrong. We've seen the same issue with Apple and many others. I always say this but I will say it again: just because a company doesn't meet some arbitrary numbers predicted by some analysts over a short period of time doesn't mean the company's success is coming to an end. Many great companies have failed to beat estimates for a quarter or two but this didn't take anything away from their greatness. Keep in mind that Starbucks missed the expectations by only 2 cents (i.e., 43 cents vs. 45 cents per share).
Globally, the company's same-store sales grew by 6%. Given the economic conditions many countries are facing today, I would call this impressive. Europe is in a recession as we speak and it may be able to drag the economies of the rest of the world down with itself. In addition to the same-store sales growth, the company generated 12% revenue growth in China and 7% in the U.S. due to the new store openings.
In Europe, the revenue was pretty much flat compared to last year. Until the issues in Europe are solved—which may take several years—most of Starbucks' growth will come from North America and Asia. This year, the company will spend about $20 million to close down its least profitable stores in Europe. In the long run, this should help with the overall margins.
While I admit that Starbucks enjoys a P/E ratio much higher than some of its peers, I don't think its P/E ratio is so bad, especially after the recent plunge. Currently, the company's trailing P/E ratio is 25 and forward ratio is nearer to 20. When a company trades for a P/E ratio above 50, like Chipotle did a month ago, this can be a dangerous; however, a P/E ratio just above 20 for a fast growth global company is not that bad.
I expect Starbucks to form a bottom sometime this week and start trending up in the following months as long as the market doesn't see wild plunges like it did last fall. Before the plunge of the company's share price, I believed that it was either fairly valued or slightly overvalued, but now the company trades at a relatively attractive value.
Rising commodity prices, slowing economy and tight competition will be the biggest threats in front of the company. Most of these issues will clear once the economy improves. I especially like the simplicity of Starbucks' business model because it drives margins high for the company.
This year, the company expects to earn between $2.04 and $2.14 per share. The average analyst expectation was $2.28. This was probably the biggest disappointment in the company's earnings report. While the economic environment will continue to be uncertain in the short term, the company will continue to open new stores, particularly in China and the U.S. The company expects to add 1,200 new stores to its portfolio.
I don't think things are so bad with Starbucks. The company continues to grow and be profitable. It enjoys high margins and customer loyalty. If it is able to manage its store portfolio a little better by closing down unprofitable stores (e.g., many of the ones in Europe) and replacing them with more profitable ones in better locations (e.g., Asian countries where there is strong demand), the company will continue to see double digit growth for years to come. I believe that the recent plunge provides a good opportunity to go long in this stock if you have the intention to do so.
Additional disclosure: I'm long MCD.