Starbucks: It's Getting Ready To Go Sideways Again

|
About: Starbucks Corporation (SBUX)
by: L&F Capital Management
Summary

A depressed valuation is what allowed SBUX stock to rally in 2018.

That valuation is no longer depressed; it's actually quite rich.

The fundamentals aren't improving; they are just stable.

This combination of stable fundamentals and a rich valuation has historically produced sub-par returns for SBUX stock.

After being stuck in neutral for most of 2016 and 2017, retail coffee giant Starbucks (SBUX) got its groove back in 2018 and early 2019, breaking out of a two-year trading range to new all-time highs. While we think this breakout is warranted by improvements in the underlying fundamentals, we also think that those same fundamentals imply that the best is over for SBUX stock. Indeed, we think this stock is gearing up to trade sideways again for the foreseeable future.

Chart Data by YCharts

From a qualitative standpoint, Starbucks used to be the unchallenged giant in the retail coffee game. Then, consistently strong comparable sales growth slowed back in 2016-17 due to rising competition from indie coffee shops. Big QSR chains like McDonald's (MCD) also aggressively pushed into the breakfast snacks and drinks category, and stole share. This competition hasn't let up since. Consequently, comparable sales growth and traffic has been weak for the past three-plus years. Margins have slid alongside slower comparable sales growth and rising wages. The net result has been unimpressive and sub-par earnings growth.

Nothing about this narrative has changed recently. Comparable sales growth last quarter was again below 5%. Traffic growth was flat. Margins dropped. The only thing that has changed is that because SBUX stock went nowhere for two years, the valuation moved lower, and that gave the stock ammunition to rally so long as growth remained steady.

It has remained steady, and SBUX stock has rallied. But, the valuation has now moved higher to a point where further gains aren't justified by the fundamentals. The reality is this is a low growth company with stable margins, and that sort of growth profile doesn't deserve a 30 P/E multiple.

From a numbers standpoint, we break Starbucks into 3 eras:

  • 2012 to 2015:
    • Global comparable sales growth consistently north of 5%.
    • Traffic growth of 3% or better.
    • Unit growth largely north of 7.5%.
    • Steady operating margin expansion.
    • Trailing 12 month P/E multiple largely above 30, and trailing 12 month P/S multiple, on average, of 3.5.
    • This combination of red-hot sales and traffic growth, steady unit growth, strong margins, a 30-plus trailing earnings multiple, and 3.5 trailing sales multiple led to SBUX stock outperforming.

SBUX Global Comps, 2012-15 SBUX Traffic Growth, 2012-15 SBUX Unit Growth, 2012-15

Chart Data by YCharts
Chart Data by YCharts

  • 2016-17:
    • 3-5% global comparable sales growth.
    • Flattish traffic growth.
    • 8%-plus unit growth.
    • Slight operating margin compression.
    • P/E multiple of ~30, and P/S multiple of ~4.
    • This combination of sluggish comps, flat traffic, healthy unit growth, margin weakness, a 30 P/E multiple, and 4 P/S multiple led to SBUX stock trading sideways.

SBUX global comps, 2016-17 SBUX traffic growth, 2016-17 SBUX unit growth, 2016-17

Chart Data by YCharts
Chart Data by YCharts

  • 2018:
    • 2% global comparable sales growth.
    • Negative to flattish traffic growth.
    • ~7% unit growth.
    • Slight operating margin compression.
    • P/E multiple of ~26, and P/S multiple of 3.5
    • This combination of sluggish comps, flat traffic, healthy unit growth, margin weakness, a 26 P/E multiple, and 3.5 P/S multiple led to SBUX stock rallying.

SBUX global comps, 2018

SBUX traffic growth, 2018 SBUX unit growth, 2018

Chart Data by YCharts
Chart Data by YCharts

Now, let's observe where Starbucks metrics should shake out over the next few years. From Investor Day:

  • 3-4% global comparable sales growth.
  • Implied flattish to slightly positive traffic growth.
  • 6-7% unit growth.
  • Operating margin stabilization.

Those numbers make sense to us, given that Starbucks has staying power in a secular growth industry, but is also losing share in that industry to the likes of McDonald's and indie coffee shops.

Thus, over the next several years, Starbucks will have 2016-17 comparable sales and traffic growth, 2018 unit growth, and 2016-17 margin trajectory. Thus, the growth profile for Starbucks over the next several years is slightly better than the 2018 growth profile, but slightly worse than the 2016-17 growth profile.

The 2016-17 growth profile led to a sideways stock when the P/E multiple was around 30. The P/E multiple is just shy of 30 today. Thus, from a historical perspective, the go-forward growth profile for Starbucks on top of a 27 to 30 forward multiple should reasonably lead to a flat stock.

Chart Data by YCharts

Overall, we think that SBUX stock is about to fall flat again. The fundamentals aren't improving. They are just stabilizing. We've seen these fundamentals before (3-5% comparable sales growth and flattish traffic growth), and when they coupled with a 30 P/E multiple, it led to SBUX stock going nowhere in 2016-17.

The P/E multiple on SBUX stock today is just shy of 30. Thus, it is reasonable to assume that this stock is getting ready to trade sideways again.

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.