Bill Ackman Goes Long on Starbucks
Bill Ackman (Trades, Portfolio), the billionaire investor who runs Pershing Square Capital Management, is making headlines once again.
During an interview with CNBC in early March, the guru said "hell is coming" for U.S. equity markets. Going a step further, he revealed a short position on the broad market. What followed was a catastrophic market event that wiped billions of dollars off the table. In a letter to investors on March 25, Ackman revealed his short bet on the market has resulted in a net profit of $2.5 billion within just a couple of weeks. He goes on to discuss how he turned $27 million into more than $2.6 billion amid the chaos. The guru ends the letter by reassuring his investors that equity markets will recover sooner than expected along with the measures taken by authorities across the world to curb the spread of Covid-19. He went on to reveal that the money he made was put back on to work by betting on companies that will deliver stellar returns in the coming years. Ackman wrote:
"We have redeployed substantially all of the net proceeds from our hedges by adding to our investments in Agilent, Berkshire Hathaway, Hilton, Lowe's, and Restaurant Brands. We have also purchased several new investments including reestablishing our investment in Starbucks which we sold in January. The proceeds of the hedges have enabled us to become a substantially larger shareholder of a number of our portfolio companies, and to add some new investments, all at deeply discounted prices."
The investment is Starbucks Corp. (NASDAQ:SBUX) is an indication of his belief that both the United States and China will be back to their normal states sooner rather than later as the company depends on these regions to generate the bulk of revenue and earnings. In this analysis, we will discuss whether Starbucks is an appealing investment opportunity for value investors.
The growth story is still intact
The company's revenue has grown two-fold over the past decade, from $10.7 billion in 2010 to $26.9 billion in 2019. This was possible because of the forward-looking initiatives implemented by the company throughout this period. Net income has also increased, albeit at a more moderate pace, due to the operating margin contraction experienced in the recent past, which was likely a result of competition in the company's major business locations.
There are a few reasons to believe Starbucks is in a position to grow its earnings per share by double digits in the coming years. The key to the success of the company has been and will continue to be its focus on providing a seamless, convenient purchasing experience for customers.
According to data from eMarketer, approximately 37% of global smartphone users used mobile payment options to shop online and to pay for their subscriptions in 2019. In-store usage of such payment options has been on a secular growth trend as well, driven by the increasing popularity of non-cash transactions. The number of worldwide mobile payment users is projected to surpass 1 billion in 2020 and grow to 1.31 billion in 2023 thanks to the increasing connectivity in both developed and emerging markets. Starbucks, as the leading specialty coffee retailer in the United States, is in a strong position to benefit from this trend. As of October 2019, Starbucks had more than 25 million users in the U.S. who used mobile payment options at least once every six months, and the company was only second to Apple Pay.
Source: eMarketer.
In addition to embracing macroeconomic trends such as the changing ways of how people execute transactions, Starbucks is continuing to innovate with its product offering as well. For instance, the company launched the nitro cold brew in 2018, which was compared to Guinness Stout based on the look and texture of the coffee. In 2019, the Fast Company identified Starbucks as one of the most innovative companies in the world, which is an indication of its commitment to changing the way people consume coffee. This will lead to it generating a high return on investment as premium prices can be charged for novel products.
Further, management plans to increase Starbucks' share of the global coffee market by expanding out of specialty retail. For instance, the company partnered with Nestle (XSWX:NESN) in May 2018 to form the Global Coffee Alliance, under which Nestle is distributing Starbucks packaged coffee through its regional network. These types of partnerships will enable the company to penetrate densely populated countries such as India, which are vital to the growth story.
The massive investments the company has made in the recent past were not limited to improving the digital experience. As confirmed in the fourth-quarter earnings conference call, Starbucks is investing to provide a more robust experience to in-store customers as well. In addition, the company is looking at opening new stores as a measure of gaining market share, which was evident from the 16% increase in store count in 2019. What is more striking is that comparable sales grew 3% in 2019 on a year-over-year basis, according to company filings. This underpins the strong momentum of the company.
Capital expenditures, however, are projected to decline in the next five years as growth opportunities diminish. This, on the other hand, will enable the company to allocate more cash to repay debt and to improve the balance sheet's health. There are early indications to suggest that Starbucks will go down this path.
Finally, the loyalty program, Starbucks Rewards, is proving to be value accretive as well since it provides consumers with a reason to remain true to the coffee chain despite the growing number of substitutes available. The company is focusing on building an ecosystem around its products, which is the right way to sustain profit margins and remain the leader of the industry on a global scale. Rewarding loyal customers with points and handing out free drinks to celebrate birthdays with them are all part of this plan.
Takeaway
Right now, many investors are paying attention to the latest developments of Covid-19 and are failing to look at the long-term picture of many companies. There is little doubt Starbucks will report disappointing earnings growth in the first half of the year. A two-month-long lockdown in China and the possibility of a nation-wide closure of business activities in the U.S. will lead to a drastic decline in revenue. However, many Western nations will likely follow China's lead and contain the spread of the virus within a few months. The company has what it takes to survive these trying times and emerge even stronger when things get back to normal.
Ackman was right to short the market a couple of weeks ago, and he will most likely be proven correct once again when Starbucks shares soar as soon as coronavirus fears dissipate. The company's price-earnings ratio has declined to 21 from the recent highs of over 30, and a partial convergence with the five-year average earnings multiple of 29 can be expected in the second half of this year when the global economy recovers.
Disclosure: I do not own any stocks mentioned in this article.
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This article first appeared on GuruFocus.
