The first three months of 2019 were kind to shareholders of Starbucks (NASDAQ:SBUX). On April 1, the coffeehouse chain out of Seattle reached an all-time high stock price of $74.93. Year-to-date, Starbucks stock is up over 15%.
In general, winners keep winning in the stock market. Starbucks has a great core business and its stock is likely to keep rewarding investors well into the future.
Here is why …
Starbucks Stock Has Robust Fundamentals
The coffee giant whose history dates back to 1971, went public in 1992. Since its initial public offering (IPO), SBUX stock has had impressive growth, well over 22,000%. Over the years, the stock has split several times; it has also been paying dividends since 2010.
The current dividend yield in Starbucks stock stands at 2.0%.
On Jan. 24, Starbucks reported better-than-expected quarterly earnings and revenue, buoyed by strong holiday sales. The earnings came at 75 cents per share, an increase of over 15% from the year-ago quarter.
Within the quarter, membership in its loyalty program, My Starbucks Rewards, has almost doubled, too. Similarly, in 2018, its U.S. gift card sales went up by 12% to $2.6 billion. Following the upbeat conference call, Starbucks raised its guidance for fiscal 2019 earnings.
During the Annual Meeting of Shareholders held on March 20, the company introduced a new $2 billion stock repurchase program that will be completed by June 2019. Management discussed several customer-friendly changes to its loyalty program, too. Wall Street also noted the various steps SBUX is taking to make the company reach more environment-friendly goals in sustainability, recycling and composting.
Finally, Starbucks announced its first-ever investment in a growth-oriented private equity fund, Valor Siren Ventures. This fund focuses on retail technologies and innovation, an area that may help Starbucks serve its retail clients better. Although the result of all the steps on the SBUX stock price would possibly require some time to materialize, the week following this Investor Day presentation, its price has already reached a new all-time high.
Power of the Starbucks Brand
Long-term investors should also consider the strength of the group’s brand: Starbucks is regarded as the “most valuable” restaurant brand. From its early days onward, the company’s brand identity has centered around offering customers a relaxing and quality experience, especially within the store itself.
Strong brands give a company increased ability to enter new markets and to raise prices, boosting revenue growth. Currently, SBUX derives most of its revenue from high-margin specialty drinks. Indeed, a 2013 research report concluded that Starbucks customers would be willing to pay more for their coffees.
And the power of the brand makes Starbucks stock a favorite with a range of exchange-traded funds (ETFs) and mutual funds, increasing the demand for the stock. For example, the largest ETF holder of SBUX is the SPDR S&P 500 ETF (NYSEARCA:SPY), with approximately 13.87 million shares. On an anecdotal note, according to Robinhood, a trading app, Starbucks stock is one of the most popular on its trading platform.
Starbucks’ Long-Term Ambitions in China
Investors in the Starbucks stock would certainly be relying on the power of the company’s brand as it increases its presence in China. As of early 2019, Starbucks has over 3,500 stores in China, making the country its second-largest market after the U.S. SBUX is expected to open almost 600 stores a year, a rather ambitious growth projection.
Before China, the group’s international expansion began in 1986 in Japan, followed by the U.K. in 1998. It opened its first Chinese store in 1999. Over the past three decades, SBUX, which in some ways has introduced the European coffee culture to the U.S. consumer, became the brand that has made coffee drinking a regular daily routine in many cities globally. Now it wants to dominate the Chinese coffee shop market, too.
Traditionally, China is a tea-drinking country. Coffee growers and chains like Starbucks are excited by the potential in the country as the market is expected to grow almost 10% per year. The group’s biggest competitor is the homegrown chain Luckin Coffee, which relies on its popular app to order and pay as well as its convenient pick-up and delivery.
According to Starbucks’ Jan. 24 earnings call, the same-store sales in China were up 1% for the quarter. However, as the number of Chinese transactions was down 2%, SBUX’s premium prices and not more foot traffic drove up the results. Management is optimistic regarding the long-term-potential China offers. Nonetheless, investors may want to wait for the release of the next quarterly report in late April to assess the possible effect of an economic slow down in China on Starbuck’s earnings as well as the stock price.
What Could Derail the SBUX Stock Price?
The U.S. coffee shop market is fast approaching a $50 billion valuation. Yet, over the past few years, the coffee chain space has become quite saturated. SBUX’s main chain competitors now include McDonald’s (NYSE:MCD) and Dunkin’ Brands (NASDAQ:DNKN). In the retail space that includes dry coffee goods, SBUX competes with Kraft Heinz (NASDAQ:KHC), which owns the Maxwell House brand and J M Smucker (NYSE:SJM), which owns the Folgers brand.
From these big names to smaller high-end local specialty coffee shops, competition is aiming to take a slice of SBUX’s market share, either by undercutting Starbucks on price or offering a different and “better” in-store customer experience. The company’s market share among leading U.S. coffee chains is an impressive 40%. However, if Starbucks management fails to underestimate the potential threat from any of the competitors, the stock price may easily take a pause.
In the more immediate weeks, there might also be some profit taking in Starbucks stock. As a result of the recent impressive run-up in the stock price, short-term technical indicators have become somewhat over-extended. Investors who pay attention to short-term oscillators should note that SBUX’s technical message has also become “overbought.”
In April and May, Starbucks stock may trade sideways for several weeks, and even have a pullback toward the low-$70’s or even high-$60’s level, where the stock is likely to find major support.
I would not advocate bottom-picking in case of near-term price weakness. Yet, I find SBUX stock to be a compelling buy candidate and by the end of 2020, I ‘d expect the shares to reach $90.
Therefore, if you already own SBUX stock, you might want to hold your position. That said, if you are worried about short-term profit taking, then within the parameters of your portfolio allocation and risk/return profile, you may consider placing a stop loss at about 3-5% below the current price point, to protect your profits to date.
If you are an experienced investor in the options market, you may also consider protecting your portfolio with a covered call. For example, you could consider buying 100 shares of SBUX at $74.35 (closing price on Apr. 4) and at the same time selling a SBUX July 19 $75 call option, which currently trades at $2.8. The $75 option is slightly out-of-the-money (OTM), offering downside protection in case of volatility and a decline in SBUX stock.
This call option would stop trading on July 19, 2019 and expire on July 20.
The Bottom Line on SBUX
When investors buy a stock, they pay that purchase price for a claim against that company’s future earnings, with the view that their investment will generate returns that will beat those of the broader stock market over the long term.
Are more gains ahead for Starbucks stock? It’s impossible to know for sure, but there are reasons to believe that the stock price could see new highs. Although there might be some profit-taking in the coming weeks, any dip in the price of Starbucks stock could be regarded as an opportunity to go long in SBUX.
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.
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