Starbucks: A Pricey Play On A 2021 Recovery
Summary
- Q2 numbers were, expectedly, negative; however, the extent to which same-store sales are declining in April was a negative surprise.
- The China recovery is taking shape, with a nine-month recovery on the cards.
- Starbucks is well-positioned to weather COVID-19, but this has largely been embedded in the price.
- At 25-30x normalized EPS, the stock offers investors little margin for error.
Starbucks (NASDAQ:SBUX) is admittedly an industry leader with clear competitive advantages, but even it may not be immune to what I believe will be a shift in consumption habits, not only in the US but globally. To be clear, I do not think consumption habits are broken, but it may take time to rebuild. At 25-30x normalized EPS, the stock is pricey and offers investors little margin of safety should a second COVID-19 wave materialize. Thus, despite my admiration for the brand, I think the stock price, at current levels, may have moved too far too fast, and thus, I would hold off on SBUX for now.
Steep Declines Across Geographies
Though expectations were low coming into the quarter, the true extent of the COVID-19 impact on Starbucks' numbers across the Americas was certainly a surprise for me. On the one hand, the March quarter saw a relatively benign impact, with a 3% decline in same-store sales (SSS), largely driven by a 7% decline in transactions.
Jun-19A | Sep-19A | Dec-19A | Mar-20A | |
Americas | 7% | 6% | 6% | -3% |
Transactions | 3% | 3% | 2% | -7% |
Ticket | 4% | 3% | 3% | 5% |
Source: Company Data
In April, however, US company-operated SSS is currently running at -25% for April, with overall SSS at -60-70% and half of the store base closed at present. Management has guided toward a material improvement to SSS numbers upon the staged openings of stores from May 4th, with a targeted 90% of the store base expected to reopen by June. I would note, however, that the guide incorporates only 30 open cafes reopening, though these stores will not have seating.
So since the third week of March when we initiated widespread closures of stores in the US, we've seen the comps which include the impact of closures based on how we defined comps for this period of time as being fairly steady in the range of minus 60% to minus 70% as we have in recent weeks reopened some more of our drive-thru stores, we've seen slight improvement within that range so that we're closer to the minus 60% end of that range.
On the International front, SBUX posted a steeper SSS decline of -31%, which was slightly ahead of consensus at -33.2%. Like the US, a decline in transactions has been the key driver, with ticket prices generally holding firm. Over 75% of company-operated stores in Canada, Japan, and the UK, along with approximately 50% of global licensed stores are currently closed.
Jun-19A | Sep-19A | Dec-19A | Mar-20A | |
International | 5% | 3% | 1% | -31% |
Transactions | 1% | 1% | -1% | -32% |
Ticket | 3% | 3% | 2% | 1% |
Source: Company Data
The China Recovery Appears Optimistic
China has likely seen the worst of the COVID-19 impact, with Q2 SSS at -50%, and April SSS running closer to -35%. Expectations are for a decline in the 25-35% range in Q3 and a flat to 10% decline in Q4, implying a nine-month recovery.
Jun-19 | Sep-19 | Dec-19 | Mar-20 | |
Comp | 6.0% | 5.0% | 3.0% | (50.0%) |
Traffic | 2.0% | 2.0% | 1.0% | (53.0%) |
Ticket | 4.0% | 3.0% | 2.0% | 3.0% |
Source: Company Data
Going forward, management expects China's impact on the full-year consolidated revenue and EPS to be approximately double Q2, implying an $800m and $0.30-0.37 impact, respectively. Nonetheless, there is a clear path to recovery emerging, and management is thus, optimistic that the business will "fully recover." Encouragingly, unit development has resumed, though the guide has reduced to 500 units for the year (vs. the initial 600 guidance). To date, China still saw 59 net opens, bringing the total store base to 4,351.
Jun-19 | Sep-19 | Dec-19 | Mar-20 | |
China | 3,924 | 4,125 | 4,292 | 4,351 |
Net Opens | 133 | 201 | 167 | 59 |
YoY % Growth | 16.0% | 17.1% | 16.5% | 14.8% |
Source: Company Data
The fact that China comps are set to climb is a notable positive, yet with 98% of stores open, April comps of down 35% are still slow, especially relative to trends at YUM China, which has guided toward -11% at KFC and -31% at Pizza Hut. Part of this is likely attributable to the fact that 80% of sales in pre-COVID-19 China were consumed on-premise, given the brand's differentiated "third place"/cafe offering.
Just real quick, on China, traditionally, we've seen 80% of our business be stay-in and enjoy their drinks in the cafes.
Given this sales mix, the updated assumption by management for recovery from -25 to -35% in Q3 toward roughly flat by Q4 seems optimistic. Note also that many stores in China that have reopened remain with limited seating capacity and reduced hours. In China, the shift toward takeaway has also been limited at around 29% (vs. 80% in the US). For the full-year, the company remains on track to open 500 net new stores in China (over 80% of its initial target).
Quantifying the COVID-19 Impact
Modeling a Starbucks recovery will be tricky, given its diverse mix of locations. As management pointed out, malls (approximately 8% of US locations), office parks, and licensed airport locations are likely to take a longer time to recover and reopen relative to the rest of the store base.
If it's stores near office parks, where office workers are not going back to work yet, they'll be a little slower. And then I think we anticipate that the mall stores will also be slower and that mall stores are fewer than 8%, I think, of the total store fleet in the US.
Other major company-operated markets such as Canada, the UK, and Japan have high closures as well and are likely to follow a similar recovery pattern as the US. Thus, the recovery of the US business is the key driver, with visibility likely to improve as the majority of closed stores are reopened over the next month.
Overall revenue took a hit of $915m, of which $450m came from the Americas and $465m from international. With 80% flowing through to the operating profit line, this implies a $700m impact, of which Americas contributed $420m and international $280m. The 76.5% loss flow-through compares to a more typical 50% flow-through rate, with the additional impact stemming from additional COVID-19-related investments such as catastrophe pay, enhanced benefits, inventory write-offs, and store safety. Expect the rate to normalize gradually going forward, however, as stores reopen, pay is normalized, and the operations team further optimizes locations for financial performance.
We estimate the COVID-19 impact to non-GAAP operating income to be approximately $700 million, inclusive of the amounts I cited for the Americas and International. In relation to the $915 million of consolidated revenue impact that I mentioned earlier, this equates to approximately 80% of flow-through on lost revenue, which is materially higher than the 50% variable flow-through rate that we typically observe in our business, reflecting the significant investments we've made in the short term to support our partners and manage our brand for the long-term.
Unsurprisingly, management did not provide an official guide, though I'd expect the financial impact to get significantly worse in Q3, before gradually improving in 4Q given US trends. Management will provide an update in early June after store reopenings to gauge the trajectory of SSS improvements. At this time, however, it appears as if a return to positive SSS will be extended into 2021.
Another key point that has received little attention thus far is Starbucks' new digital tool to monitor consumer habits through its drive-thru and other off-premise operations as part of the "Monitor and Adapt" phase, which began in China. Under "Monitor and Adapt," Starbucks will leverage data at the community and store-level to determine if it is safe to reopen. Through the tool, management is also better positioned to gauge store productivity and the rate at which customers are recurring. On the latter point, management's disclosure that 90-day active My Starbucks Reward (MSR) members still stand at 19.4m (implying a 15% YoY growth through COVID-19) was particularly bullish, highlighting the floor around Starbucks' recurring sales base.
Source: Digital Dashboard
Well-Positioned to Weather the Downturn
Starbucks' liquidity position is strong, with cash and short-term investments at $2.6bn as of end-Q2 and supplemented by $1.8bn of further liquidity from debt raised on March 12th. The company has further reduced the previous $1.8bn 2020 capex guide to $1.5bn, partly by shifting the planned store openings in China out to 2021. Nonetheless, COVID-19-related expenses such as premium pay, flexible payment terms for licensees, and supplier payment acceleration will weigh on near-term cash flow.
Source: Starbucks 10-Q
The guided cash burn rate of $125m per week includes the full sales impact, capex, and partner forward elective pay, but does not include dividends and likely represents the peak. From here, I expect the burn rate to decline as stores reopen gradually. In the meantime, management has prudently suspended repurchases, reduced discretionary spending, and capex cuts should also help offset the cash burn. Debt levels have also been increased to bolster liquidity, driving rent-adjusted leverage above the 3x target this year, though I believe SBUX is well-positioned to de-lever below this level in 2021.
Overall, I believe SBUX's fundamentals are sound. Clearly, it is a dominant, well-managed business, positioned well to outlast yet another recession. Thus, I have little doubt that the company will navigate the upcoming reopening well. However, this is still a cyclical business, and even though we are in a recession, valuations still seem far too pricey for me. SBUX's quality appears to be well-understood by the market and, thus, even if sales do recover, I do not see much upside from here. Even assuming diluted EPS returns to the $2.80-2.90 region by fiscal 2021 (an optimistic scenario incorporating no second COVID-19 wave), SBUX is trading in the 25-30x EPS range. If, however, we experience further negative surprises, SBUX could be exposed to a material correction, keeping me on the sidelines, for now.
This article was written by
Analyst’s 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (16)
A Few OTM calls have served me well. Buy when people are fearful......TY Mr. Buffett.
