Evie Liu
Barron’s
June 14, 2024
Starbucks is brewing plans for a turnaround after surprisingly weak second-quarter earnings. Same-store sales at the world’s largest coffee chain declined 3% in North America and 6% in international markets, the result of soft demand and more competition in China. The stock, which has slumped almost 17% this year, now looks oversold. Starbucks is still growing at a rapid pace and continues to adapt through smaller stores, greater efficiency, and diverse products to attract new customers. If those measures are successful, the stock could see a big bounce.
Americans are also drinking coffee more than ever. The National Coffee Association reports that two out of three adults in the U.S. this year had coffee in the past day. The share of consumers who bought from coffee shops in the past day nearly doubled to 15% in 2024 from 8% the year before. The U.S. coffee shop market grew 8% over the past year to nearly $50 billion, now standing 4% above prepandemic levels, according to the Project Café USA 2024, an industry report from coffee consulting firm World Coffee Portal. And Starbucks, with more than 16,000 outlets in the U.S., remains the leader, with a 40% market share. “It’s tough to keep growing the same-store sales, but Starbucks remains a formidable brand that’s operating at an unprecedented scale in the global coffee market.” says Jeffrey Young, CEO of Allegra Group, the parent company of World Coffee Portal. But Starbucks is facing some headwinds. Inflation has curtailed consumers’ willingness to spend. Boycotts stemming from its position on the Israel-Hamas war, and workers’ unionization efforts are taking a toll. Boutique coffee shops and smaller chains like Dutch Bros and Scooter’s Coffee are growing quickly, elbowing in on Starbucks’ business. Instead of getting a cheaper item on the menu, consumers often stop buying from Starbucks entirely and get their fix at convenience stores or at home. And, Starbucks doesn’t get the trade-down business from higher-end brands because it’s already the premium player in the coffee market. “The casual drinker who might stop by for an afternoon cold brew or weekend Frappuccino has fallen off the map,” says Morningstar analyst Sean Dunlop. Still, Starbucks continues to grow. In the past four quarters, it added nearly 600 new stores in North America and 1,700 overseas. In emerging markets like India, Southeast Asia and Latin America, penetration is still low, presenting room for growth.
This could help buffer any short-term weakness in the domestic market. Despite the expanding footprint, there is little sign of cannibalizing. Average annual sales for company-owned stores continue to rise, reaching $2.3 million in fiscal 2023. “They are the dominant player of an addictive product. You really can’t get a better business model than that,” said Burns McKinney, a portfolio manager at NFJ Investment Group, which owns the stock. Beyond the unparalleled scale, what’s kept Starbucks ahead is its ability to continuously innovate its business model and products.
The company has gone through a major shift toward cold beverages in the past decade; those now accounts for over 60% of its drink orders. Many are customized with flavored syrups and extra espresso shots, which not only differentiate the brand from competitors but also are more expensive. And Starbucks continues to roll out new products to attract younger customers, who are increasingly looking for interesting flavors and textures. Lavender-flavored drinks, which made their debut this spring, have been hits, according to the firm. Starbucks also has launched drinks with soft jelly balls—so-called “pearls”—and new energy beverages are on the way. Those could help boost sales in the afternoon, says Eric Strange, a portfolio manager at Bahl & Gaynor, whose fund owns the stock.
While Starbucks prides itself as a “third place” outside of work and home for social gatherings, it’s quickly turning into a convenience-focused brand. Much of its new stores in the past few years came with drive-through lanes, and mobile orders now make up 31% of total transactions. The ballooning number of orders and special customer requests have brought some operational challenges. In the latest earnings call, management noted that a midteens percentage of Starbucks’ mobile orders weren’t completed, likely due to long waiting time. The company is taking steps to become more efficient, adopting, for instance, a compact workstation that eliminates the need for baristas to move back and forth when making a cold drink. It’s also rolling out machines to brew coffee more quickly and keep food warm and ready for pickup.
“As consumers start to feel better, Starbucks will get a transaction lift from some of these investments they’re making now,” says Morningstar’s Dunlop. “Our team is working hard to reaccelerate growth and momentum in our U.S. business,” Starbucks told Barron’s. A social media boycott, which stems from Starbuck’s dispute with the Workers United union, hurt sales, according to the company, which maintains that misinformation was a cause of the boycott.
But management has been negotiating a contract with the union since April, and thawing relations could help quell some of the negative media sentiment about the company. “It looks like Starbucks and the union have come to an agreement not to drag each other through the mud in public,” says BTIG analyst Peter Saleh. “Instead, they’ll negotiate privately, which is probably a good thing for sales in the near term.” The stock is down to around $80, 29% below its recent peak in April 2023. Shares are now trading at 20 times next fiscal year earnings, much lower than the five-year average of 28 times. It’s a rare opportunity for investors to buy now. Among analysts polled by FactSet, the average target price is $88, indicating a 9% gain. But the upside can be much larger: Earnings are estimated to grow 13% year-over-year to $4.07 per share in fiscal 2025. If the valuation recovers to the five-year average, the stock could breach $114. The headwinds likely won’t disappear in one or two quarters. Flattish sales and elevated capital expenditures could squeeze earnings and cash flow in the short term, but the issues seem more transitory than structural. “You have to be patient, but if you can, you’re getting a premium brand name at a discount,” says NFJ Investment’s McKinney.