Trade of the Day: Starbucks Corporation (SBUX)
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Starbucks Corporation (NASDAQ:SBUX) was hit with a selling frenzy on Wednesday and Thursday after announcing that it would be closing 150 U.S. stores. From Tuesday’s close to Thursday’s close, the stock dropped nearly 12%, which is a big move for SBUX.
Lower same-store-sales growth is a metric investors use to measure sales growth in locations that have been open for more than a year. It is considered a better gauge of organic growth than total revenue for retail companies like Starbucks. The store closures were blamed on lower-than-expected sales and worries about profit growth in China.
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These facts are accurate so far, but it’s not the first time SBUX has hit a bump like this. The company is cyclical in nature, and the stock hit $51 per share the last two times there was an expected slowdown in same store sales and international expansion since 2015. The concerns were valid then and now, but the cause of the slowing this time has potential short-term solutions that we believe increase the potential for the stock to recover — and even break out later in 2018.
SBUX has successfully launched and promoted its My Starbucks Rewards (MSR) digital program. As many of you already know, you can use the app on your phone to order and pay for your purchase before getting to the store. The launch was so successful, it initially led to problematic bottlenecks during peak hours. Additionally, concerns about sales growth is relative to a revenue and profit baseline that is much higher than it was in 2015-2016 largely because of the MSR program.
Part of the issue this year was created when Starbucks was dealing with a corporate culture and PR problem that resulted in the company revising and reemphasizing their racial bias training. SBUX closed thousands of stores and took hundreds of thousands of employees briefly out of production in May to attend training. Hopefully, this will help prevent future incidents like the one in April of this year when a Philadelphia branch employee called the police, who then forced two black customers (who were waiting for another friend to arrive) to leave the Starbucks store.
One of the results of the PR disaster was a postponement of major marketing campaigns — including those oriented towards growing MSR sign-ups. Investors shouldn’t have been surprised that the company would cut costs this quarter by closing lower-performing stores and kiosks. However, the new marketing strategy will build on strength by allowing non-MSR customers to use the app and by rewarding customers who have registered a credit or debit card with the company. Closing a few stores in high-rent, metropolitan areas that are overrun by SBUX stores already seems to be a prudent way to streamline retail operations in those areas and pay for growth in the Central and Southern U.S.
Our premise for this trade is that we have seen SBUX go through this cycle before. This time, although the share price is the same (near $51 per share), the underlying growth and profitability numbers are much better. We believe SBUX is extremely oversold because the market is jittery about trade, and institutional investors were anxious for any excuse to rebalance. Investing in favor of a rebound seems like a great idea right now.
Much of the growth for Starbucks has been happening in China and across Asia over the last few years. Slowing economic growth in China has been a concern for some analysts who have been lowering their price targets for the stock.
This was a very similar chain of events compared to what we saw in June-August of 2017 and in July of 2015 when the stock was very close to the same level is has been this week. Growth in China is an issue, but there seems to be little evidence that the company will return to revenue and profit numbers from 2015-2016, which might have otherwise justified the decline this week.
As previously mentioned, SBUX’s price is back to the extreme lows it hit in 2016 and during the market “flash crash” of August 2015. We expect investors to build a support level at this point that will hold in the near term. The market is choppy enough that we think this still justifies a hedged entry into the stock with a short put rather than an outright purchase of the stock.
‘Sell to open’ the SBUX July 27th $51 Put (SBUX180727P00051000) for a target price of $1.30.
Selling a put here will allow us to profit even if the stock remains flat. We may wind up owning the stock (unless we exit early) if it drops below the $51 strike price before expiration. However, depending on market conditions, that may not be a bad outcome, and one could sell calls against a long position while waiting for bullish momentum to build if that occurs.
What we expect is for SBUX to remain above $51 per share before expiration on July 27, which would result in a return of 11%+ on the trade based on the margin requirement.
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