With the Federal Reserve forecast to raise interest rates by just 25 basis points in the next year, dividends are likely to continue to be of great importance to investors. With the S&P 500 yielding 2.1%, Starbucks' (NYSE: SBUX) yield of 1.4% may cause many investors to look elsewhere for income potential. However, we think there is much more to income investing than the headline yield and believe that Starbucks' dividend growth potential is stunning for these three reasons.
Although loyalty programs are no longer novel, Starbucks' loyalty program is resonating exceptionally well with customers. In its Q3 update, Starbucks highlighted the fact that membership in its loyalty program increased 18% year on year to 12.3 million active loyalty members in the US. And with 17% of US adults receiving one as a gift over the 2015 holiday season and around $2 billion loaded onto them in the US in Q1 of the current year, it is clear that they are popular and becoming increasingly so.
In our view, this presents a major opportunity for Starbucks to better understand its customers and increase its margins. Spending data from the loyalty program will allow Starbucks to optimize factors such as store locations, products sold in a particular locality, as well as offers and discounts offered to individual card members. Further, the loyalty program should cause Starbucks' customers to become increasingly attached to the company and we feel that this could provide pricing potential and improving margins. As such, we think that Starbucks' loyalty program could act as a positive catalyst on its profitability, dividends and share price moving forward.
In tandem with Starbucks' loyalty program is the investment being made in Starbucks' digital offering. In its Q3 update, Starbucks stated that the use of its Mobile Order and Pay app increased, with it reaching 5% of US transactions. This is up from 4% in Q2 2016 and with Starbucks rolling out digital payments in China and Japan in recent months, it is building on its rapidly expanding portfolio of digital innovations in the region.
In our view, Starbucks' digital strategy is very sound and it provides added convenience, efficiency and a better customer experience. This should enhance customer loyalty towards Starbucks and this could lead to improved sales and profitability. Therefore, investment in its digital offering could positively catalyze Starbucks' financial performance and boost its dividend and share price moving forward.
Starbucks has increased its presence in China in recent years and it expects to open 900 new stores in China/Asia Pacific in the current fiscal year. In our view, opening more stores in China is a sound strategy which will positively catalyze Starbucks' earnings and share price moving forward since demand for consumer discretionary products in China is expected to rise by 7% per annum between 2016 and 2020.
And with incomes among urban dwellers in China set to rise over the next six years so that three-quarters of urban dwellers earn between $9k and $34k per annum, the market for consumer goods such as Starbucks coffee is likely to rapidly rise. Evidence of this can be seen in the increase in sales in the Asia Pacific region in Q3, with sales rising by 18% and operating income increasing by 22%. Comparing this with the top line and operating income growth in the Americas of 7% and 5%, respectively, in the same period highlights the growth opportunity which Starbucks has in China/Asia Pacific. As such, we think its aggressive store opening strategy in the region will positively catalyze its financial performance, dividends and its share price moving forward.
Clearly, Starbucks is not without risk, and while we think that its international expansion will act as a positive catalyst on its profitability and share price, it also means that Starbucks is exposed to the possibility of a negative currency translation from a strengthening dollar. As mentioned, the Federal Reserve is forecast to raise interest rates by 25 basis points in the next year.
While this may be a relatively small amount, policymakers across the globe are adopting more dovish viewpoints, with the UK and Australia cutting interest rates recently. As such, the US dollar is forecast to strengthen over the next year against a basket of the world's major currencies and as a business with a significant proportion of its earnings generated outside of the US, this could hurt Starbucks' profitability in the short run.
Despite this, we think that Starbucks' financial outlook, dividend growth potential and share price will be positively catalyzed by its growing loyalty program, digital investment and its aggressive store opening program. As such, we think that while it has a yield of only 1.4%, Starbucks will become a top notch income stock 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.