If you read my work, you know that I haven’t been the biggest fan of Starbucks (NASDAQ:SBUX) stock.
I’ve always looked at SBUX stock as a case of slowing growth prospects converging on an outsized valuation, a combination which led me to label SBUX as the ultimate sideways stock.
But, in my bearish coverage on SBUX stock over the past 12-plus months, I’ve also stated that if the stock dropped in a big way, there would be an opportunity to buy the dip.
The logic was that Starbucks is still a global coffee powerhouse that has solid long-term growth prospects. Once the stock price fell and valuation compressed to match those growth prospects, then that would be the time to buy.
When does the price tag match the growth prospects on SBUX stock? Below $50.
Where is SBUX stock today? Below $50.
Thus, I think it may be time to start buying the dip on SBUX stock. I’m not saying there will be a big rebound here and now. But below $50, the stock price is supported by fundamentals, and as such, further downside seems limited.
Here’s a deeper look.
The Starbucks Narrative Could Change Course Soon
I’ve always viewed the Starbucks narrative as one that has consistently weakened over the past several years. Competitive risks were mounting from fast-casual chains on one side and trendy indie coffee houses on the other side.
Growth was permanently slowing as a result, as evidenced by comparable sales growth falling below 5% for the first time in several years a few quarters ago and staying below 5% ever since. Margins have been under pressure because comparable sales growth has slowed, and the whole narrative has been rather weak.
But, I think that narrative hit a bottom recently.
The most recent leg lower in SBUX stock has been a big one. Indeed, the fall from $57 to $48 in a few weeks is an unprecedentedly big drop for SBUX considering the short time frame.
From a technical perspective, the drop seems overdone. The Relative Strength Index (RSI) has dropped to a five-year low and is now well into over-sold territory. The stock is as far below its 200-day moving average as it has been over the past five years, a divergence which implies a bounce back is coming soon.
From a fundamental perspective, the drop also seems overdone. Granted, the third quarter update wasn’t great, and a bunch of top execs, including Howard Schultz, are leaving the company.
But, the valuation now seems to reflect a much more dour outlook on the stock. One of my biggest knocks on SBUX stock in the past was that this was a coffee house operator trading at a huge premium to the market. Now, though, the forward earnings multiple is at 18, which is essentially a five-year low and 30% lower than the five-year average forward multiple of 26.
In other words, SBUX stock has fallen far in a short amount of time because investors are worried about weakening growth prospects. But the technicals scream over-sold, and the fundamentals imply that a lot of pessimism is finally priced in. Thus, it looks like the Starbucks narrative could change course soon and that SBUX stock could bounce back.
Starbucks Stock Is Now in Fair-Value Territory
Over the past several quarters and years, I have been fairly consistent in my analysis on Starbucks.
This is a company which dominates the global coffee service market. But, the company is rapidly losing price-oriented customers to fast-casual chains who are building out robust breakfast snack and drink menus at discount prices (see McDonald’s (NYSE:MCD)).
The company is also rapidly losing trend-oriented customers to indie coffee shops which offer a more mom-and-pop feel that Starbucks.
Thus, growth is slowing. And this growth slowdown is permanent. The era of 5%-and-up comparable sales growth is dead and gone.
That being said, Starbucks is the still the global leader in the coffee service game. The value prop is still strong, as prices are reasonable, and the quality is great. The company’s brand is very strong. And the morning errand of going to a Starbucks to get a coffee remains a global standard.
As such, while the era of 5%-and-up comparable sales growth is dead and gone, we also aren’t heading into an era where comparable sales growth will be negative and margins will compress. Comparable sales growth will still be positive, just in the 0-2% range, and margins will stabilize and/or head higher thanks to price hikes.
Overall, given mildly positive comparable sales growth, international unit expansion, and margin stabilization, Starbucks is a company which can grow revenues around 7% per year and maintain an operating margin profile in the 20% range. Under those modeling assumptions, Starbucks should be able to net $3.60 in earnings per share in five years.
A growth-average 20-times forward multiple on that implies a four-year forward price target of $72. Discounted back by 10% per year, that equates to a year-end price target of $54 for SBUX stock.
Bottom Line on SBUX Stock
The valuation finally appropriately reflects the company’s slowing growth prospects. As such, below $50, now is the time to buy the dip in SBUX stock.
As of this writing, Luke Lango was long SBUX.
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