It’s been quite a reversal for Starbucks (NASDAQ:SBUX) stock. In June, SBUX stock seemed to be in trouble, hitting a three-year low after a disappointing update ahead of fiscal Q3 earnings.
The company announced plans to close 150 stores in the U.S., seemingly signaling full saturation of the domestic market. Global same-store sales were guided to 1% for the quarter, as the company’s big bet in Asia hardly seemed to be paying off. I wrote at the time that the dip didn’t look like a buying opportunity, given decelerating growth and a still-healthy valuation.
That analysis, to be blunt, turned out to be dead wrong. Starbucks stock has bounced 41% off its lows, and touched an all-time high earlier this month. A big Q4 beat helped SBUX climb but only has been part of the story. Clearly, sentiment toward SBUX stock has reversed and done so quickly.
Despite being wrong on the stock this summer, I’m still skeptical. FY19 guidance doesn’t signal a notable change in growth expectations. Same-store sales growth isn’t great. The company still has work to do in China.
With SBUX stock trading at 25x the high end of fiscal 2019 guidance, the market is pricing Starbucks stock like a growth play again. Yet the news doesn’t seem to have changed all that much and certainly not enough to justify such a massive swing in valuation.
Is SBUX Stock Really Worth 40% More?
For all the gains in Starbucks stock, Q4 earnings really weren’t that impressive. Global same-store sales growth of 3% was better than consensus expectations for 2.3% and an improvement from the 1% rise seen in Q3. But transactions actually were down in three of four regions, with performance flat in EMEA (Europe, Middle East, and Africa).
Meanwhile, fiscal 2019 guidance of $2.61-$2.66 isn’t particularly notable. The average Street estimate heading into the quarter was $2.63. The figure suggests, at the midpoint, 9% growth. And operating margins, per the 10-K, are expected to compress next year.
Starbucks stock had been range-bound for years until the recent breakout. And the concerns were myriad. The U.S. market was saturated. Wage increases had the potential to pressure margins. Competition was keeping same-store sales growth down.
None of those concerns seem particularly assuaged. Operating margins are coming down. U.S. growth is slowing to a 3% net unit increase next year. Trade war concerns can hit the business in China, even bu just raising the ire of Chinese citizens toward an American company. And same-store sales still have decelerated notably, falling from 6% in FY14 and 7% in FY15 to 3% in FY17 and 2% in FY18.
That’s a profile that suggests a high-teen or maybe low-twenties earnings multiple. Instead, SBUX stock now trades at 25x earnings. Even analysts haven’t been able to catch up: Starbucks stock has passed the average Street target price of $66+.
The Gains in Starbucks Stock
What’s interesting about the gains in SBUX is that they’ve come at a time when the stock could easily have been pressured. U.S. stocks have taken a tumble since early October.
The buyout of the joint venture in China makes that market hugely important for Starbucks. One only need to look at the stock charts of Alibaba (NYSE:BABA) and JD.com (NASDAQ:JD) to see how investors feel about that economy right now.
That said, restaurant stocks have shown some strength, perhaps surprisingly given macro fears. McDonald’s (NYSE:MCD) has broken out to an all-time high, for instance. But Dunkin’ Brands (NASDAQ:DNKN) has traded sideways and Yum! China (NYSE:YUMC) is down 10%+ this year.
And there is some growth potential here. 600 new stores are going into China, and 400 licensed stores in EMEA. The company said on the call that its consumer business deal with Nestle (OTCMKTS:NSRGY) would be accretive in FY20.
It’s not as if earnings growth is falling off a cliff. There is good news here. I’m just not sure whether that good news is worth paying 25x earnings, particularly with China such a big part of the story.
Can SBUX Move Higher?
For investors willing to take that risk, there’s probably a case for SBUX. EPS likely clears $3 next year, assuming China doesn’t blow up. A 2%+ dividend yield helps the case, and the company will continue to buy back stock. With MCD and Yum! Brands (NYSE:YUM) trading at similar multiples, valuation might not be that prohibitive, either.
Still, I can’t shake the feeling that investors forgot about Starbucks’ problems awfully quickly. Nor am I certain they won’t remember them again at some point in the future.
As of this writing, Vince Martin has no positions in any securities mentioned.
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