Shares of coffee retail giant Starbucks (NASDAQ:SBUX) have been on fire over the past year, rising nearly 80% over that stretch versus a mere 3% gain for the S&P 500.
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Ostensibly, the huge rally in SBUX stock makes sense. After a multi-year stretch from 2015 to 2018 wherein competition flattened out SBUX’s growth trajectory, the coffee retail giant has since regained its groove, and is now consistently topping Street estimates on the only metric that matters in the retail world — comparable sales.
As comparable sales growth has consistently topped analyst expectations over the past year, SBUX stock has taken off like a rocket ship.
At first glance, it makes a ton of sense. But, upon closer inspection, there are some red flags which make me worried that the big rally in Starbucks stock may be on its last legs.
What are those red flags? Let’s take a closer look.
The Fundamentals Appear Stretched
The first big red flag on SBUX stock near $100 is that the fundamentals appear stretched.
Everyone is celebrating the fact that management issued guidance which calls for Starbucks to be a 3-4% comparable sales grower and 10%-plus profit grower over the next several years. Sure, those are great growth projections. But over the past five years, Starbucks has averaged 5% comparable sales growth on profit growth that was largely above 15%, and often above 20%.
During that stretch from 2013 to 2018, SBUX stock traded around 25-times forward earnings. Today, SBUX stock trades at 30-times forward earnings.
See the disconnect? Starbucks projects to grow materially slower over the next several years, than it has over the past several years, yet Starbucks stock is trading at a 20% richer valuation than it has over the past five years.
That doesn’t make much sense. Indeed, history says a 30-times forward multiple just doesn’t work for Starbucks stock. The last (and only time in the past decade) that this stock had a 30-times forward multiple was in 2015. In 2016, SBUX stock dropped more than 7%, while the S&P 500 was up more than 10%.
The Optics Could Get Ugly In A Hurry
The second big red flag on SBUX stock is that, while the optics remain good today, they could get ugly in a hurry.
Right now, everything looks good for Starbucks. Traffic growth has come back into the picture. Comparable sales growth is stabilizing. The China growth narrative appears healthy. Margins are stable. The technology and delivery integrations are working.
But I’m worried that all those positives could turn into negatives in a hurry.
Positive traffic growth? It could turn negative given that indie coffee shops are still rapidly expanding and McDonald’s (NYSE:MCD) is being relentless in its breakfast snack and drink menu expansion. Stabilizing comps? They could decelerate again if traffic growth flips back into negative territory from competition. Healthy China growth? Luckin Coffee (NYSE:LK) is growing very quickly in China, and will only become a bigger threat to the Starbucks China growth narrative over time. Stable margins? Competition could erode pricing power, forcing Starbucks to cut prices to drive traffic, which will weigh on margins.
Overall, I see very real and sizable risks on the horizon which could turn today’s favorable optics into unfavorable optics rather quickly.
The Technicals Imply A Top
The third big red flag on SBUX stock is that the long-term technicals imply that the stock could be peaking here and now.
Click to Enlarge
See the attached chart. For the most part, Starbucks has traded within very well defined bands dating back more than thirty years. Breaks above the upper band are solid medium-term selling opportunities. Breaks below the lower band are solid medium-term buying opportunities.
Right now, SBUX stock is breaking above the upper band of this trading range. If it continues to rally, it will break a trading pattern which has held true for over three decades. As such, I don’t think it will continue to rally, and am worried that the next move in Starbucks stock could be significantly lower.
Bottom Line on SBUX Stock
It seems everyone loves Starbucks stock right now. But, when I see everyone falling in love with Starbucks stock, I am reminded of the age old Wall Street adage — stocks advance on a wall of worry, and decline on a slope of hope.
That adage doesn’t always ring true. But, in this case, I think it will. There are enough red flags on SBUX stock here to warrant staying away from this red hot stock for the foreseeable future.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
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