The global coffee-chain operator Starbucks (NASDAQ:SBUX) seems to be losing steam after a powerful rally this summer. Its shares have lost more than 13% since reaching a record high of $126.32 in July.
This weakness comes after a remarkable turnaround during the pandemic, when the Seattle-based company suffered a severe blow to its business as COVID-19 spread globally, forcing offices to close and daily customers to stay at home. Since the pandemic-triggered crash in March 2020, SBUX stock has more than doubled, closing yesterday at $112.21.
Behind this surge was soaring sales in North America and other parts of the world. Global same-store sales rose a whopping 73% in the company’s fiscal third quarter, which ended June 27, compared with the same period the previous year. US same-store sales also beat estimates, and even grew 10% from two years ago— prior to the pandemic—on strong cold-beverage sales.
Despite this strong recovery in sales, investors are in wait-and-see mode as far as SBUX shares are concerned. Sales in China and surging inflation are the two most important factors showing up in the stock weakness.
During Q3, China same-store sales came in significantly below estimates, and the company said average customer spending also declined there. That trend, according to the company’s guidance, may continue to hurt the overall performance. The coffee chain now sees comparable sales growing 18% to 20% in China, down from a previous range of 27% to 32%. Starbucks also trimmed its international outlook for the same measure.
China And Wage Inflation
For Starbucks’ growth, China plays a key role. Starbucks now has more than 5,000 locations in China, with 600 new ones opening this fiscal year. It has established the market, along with the US, as its most important, so any weakness in that crucial market makes investors nervous.
In a note last week, Atlantic Equities downgraded SBUX, saying COVID restrictions in China and wage hikes may continue to pressure the stocks.
Said Atlantic Equities’ Edward Lewis in a note Thursday:
“We remain concerned that momentum for the business may be slowing more than the market might have anticipated with [comparable sales] set to return to negative territory in China and rising labour cost inflation weighing on US growth.”
Food chains have been forced to raise their wages in a tight labor market in recent months. Starbucks said earlier in 2021 it expects all retail workers to earn $15 an hour within three years.
Atlantic Equities lowered its rating on Starbucks to neutral from outperform. The firm also cut its price target on the stock to $105.
Despite these challenges, we continue to see SBUX as a long-term buy, with further weakness opening an entry door for these investors. In the long run, the coffee chain is well positioned to show strong growth after the company’s aggressive push to restructure its business.
The pandemic has forced it to rethink its central concept as a “third place,” away from work and home, where customers can relax. It’s accelerating the rollout of its “pickup” store concept, with smaller-format locations that don’t have customer seating. In the US, Starbucks is closing about 800 underperforming locations and building new store formats, like urban cafés without seating and more drive-thru lanes in the suburbs.
Over the long run, the chain is planning to build more than 20,000 additional locations in the next decade to meet its goal of reaching 55,000 locations by fiscal 2030, up from nearly 33,000 today.
The company, with an annual dividend yield of 1.8%, pays $0.49 a share quarterly, making it a suitable candidate for income-seeking investors. Its payout has grown about 21% per year during the past three years, highlighting management's strong focus on returning capital to stakeholders.
Bottom Line
Starbucks may not have more upside in the short run after a power run during the past 12 months, but we believe the stock is a good buy-the-dip trade due to its long-term growth potential.