What’s Next for Starbucks Amidst Market Headwinds?

TipsForTraders | June 14, 2024

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Starbucks is strategizing for a rebound following unexpectedly weak second-quarter earnings.

The global coffee giant reported a 3% decline in same-store sales in North America and a 6% drop in international markets, influenced by diminished demand and increased competition in China.

Despite a 17% stock decline this year, Starbucks appears undervalued. The company is expanding rapidly, focusing on smaller stores, increased efficiency, and a diversified product lineup to attract new customers. These efforts, if successful, could significantly boost the stock’s performance.

Coffee consumption in the U.S. is at an all-time high, with the National Coffee Association noting that two-thirds of American adults drank coffee daily this year. The proportion of consumers purchasing from coffee shops daily nearly doubled to 15% in 2024, up from 8% the previous year. The U.S. coffee shop market grew by 8% over the past year, reaching nearly $50 billion, surpassing pre-pandemic levels by 4%, according to World Coffee Portal’s Project Café USA 2024. Starbucks, with over 16,000 U.S. outlets, maintains a 40% market share.

Jeffrey Young, CEO of Allegra Group, emphasized Starbucks’ formidable brand presence and scale in the global coffee market, acknowledging the challenge of sustaining same-store sales growth.

However, Starbucks faces significant challenges. Inflation has reduced consumer spending, and boycotts related to its stance on the Israel-Hamas conflict, along with unionization efforts, have impacted sales. Boutique coffee shops and smaller chains like Dutch Bros and Scooter’s Coffee are rapidly expanding, encroaching on Starbucks’ market share.

Consumers often opt for convenience stores or home-brewed coffee over cheaper Starbucks menu items. As the premium player in the market, Starbucks doesn’t benefit from customers trading down from higher-end brands.

Morningstar analyst Sean Dunlop noted that casual drinkers who previously frequented Starbucks have declined. Nonetheless, Starbucks continues to grow, adding nearly 600 new stores in North America and 1,700 internationally over the past year. Emerging markets like India, Southeast Asia, and Latin America offer substantial growth potential due to low market penetration.

Starbucks’ expansive footprint has not led to significant cannibalization, with average annual sales for company-owned stores rising to $2.3 million in fiscal 2023. Burns McKinney, a portfolio manager at NFJ Investment Group, highlighted Starbucks’ dominant position in the market and its innovative approach to business and product development.

The company’s shift towards cold beverages, now comprising over 60% of drink orders, has been a key strategy. These customized drinks, often more expensive, differentiate Starbucks from competitors. New products, such as lavender-flavored drinks and beverages with soft jelly balls, aim to attract younger customers. Upcoming energy drinks could boost afternoon sales, according to Eric Strange, a portfolio manager at Bahl & Gaynor.

Starbucks’ transition to a convenience-focused brand is evident in its new drive-through stores and the significant share of mobile orders, which now constitute 31% of transactions. However, operational challenges have arisen, with a notable percentage of mobile orders remaining uncompleted due to long wait times.

The company is implementing measures to improve efficiency, including compact workstations and faster coffee-brewing machines. These initiatives are expected to enhance transaction volumes as consumer confidence rebounds, according to Dunlop.

Starbucks is also addressing union-related issues, with ongoing contract negotiations potentially easing negative media sentiment. BTIG analyst Peter Saleh noted that improved relations between Starbucks and the union could positively impact sales.

Currently trading around $80, Starbucks shares are 29% below their recent peak in April 2023. With shares trading at 20 times next fiscal year’s earnings, compared to a five-year average of 28 times, there is a unique buying opportunity for investors.

Analysts surveyed by FactSet have an average target price of $88, indicating a potential 9% gain. However, with an estimated 13% year-over-year earnings growth to $4.07 per share in fiscal 2025, the stock could reach $114 if valuations return to their five-year average.

While short-term challenges persist, they appear transitory rather than structural. NFJ Investment’s McKinney suggests that patient investors could acquire a premium brand at a discounted price.

Key Takeaways:

  1. Starbucks is working on a turnaround strategy after weak Q2 earnings.
  2. The company is expanding its footprint and innovating its product offerings.
  3. Despite challenges, Starbucks maintains a strong market position with growth potential in emerging markets.
  4. Inflation, competition, and union issues are significant headwinds.
  5. Analysts see a potential upside for Starbucks stock, offering a unique investment opportunity.

Conclusion: Starbucks faces a challenging market environment but remains a dominant player with significant growth potential. The company’s innovative strategies and expansion into emerging markets position it well for a potential rebound. Investors willing to be patient may find a valuable opportunity in Starbucks’ currently undervalued stock.