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Dilantha De Silva
Dilantha De Silva
Articles (69)  | Author's Website |

Bill Ackman Goes Long on Starbucks

The company's growth story will resume when Covid-19 fears subside

March 26, 2020 | About:

Bill Ackman (Trades, Portfolio), the billionaire investor who runs Pershing Square Capital Management, is making headlines once again.

During an interview with CNBC in early March, the guru said “hell is coming” for U.S. equity markets. Going a step further, he revealed a short position on the broad market. What followed was a catastrophic market event that wiped billions of dollars off the table. In a letter to investors on March 25, Ackman revealed his short bet on the market has resulted in a net profit of $2.5 billion within just a couple of weeks. He goes on to discuss how he turned $27 million into more than $2.6 billion amid the chaos. The guru ends the letter by reassuring his investors that equity markets will recover sooner than expected along with the measures taken by authorities across the world to curb the spread of Covid-19. He went on to reveal that the money he made was put back on to work by betting on companies that will deliver stellar returns in the coming years. Ackman wrote:

“We have redeployed substantially all of the net proceeds from our hedges by adding to our investments in Agilent, Berkshire Hathaway, Hilton, Lowe’s, and Restaurant Brands. We have also purchased several new investments including reestablishing our investment in Starbucks which we sold in January. The proceeds of the hedges have enabled us to become a substantially larger shareholder of a number of our portfolio companies, and to add some new investments, all at deeply discounted prices.”

The investment is Starbucks Corp. (NASDAQ:SBUX) is an indication of his belief that both the United States and China will be back to their normal states sooner rather than later as the company depends on these regions to generate the bulk of revenue and earnings. In this analysis, we will discuss whether Starbucks is an appealing investment opportunity for value investors.

The growth story is still intact

The company's revenue has grown two-fold over the past decade, from $10.7 billion in 2010 to $26.9 billion in 2019. This was possible because of the forward-looking initiatives implemented by the company throughout this period. Net income has also increased, albeit at a more moderate pace, due to the operating margin contraction experienced in the recent past, which was likely a result of competition in the company’s major business locations.

There are a few reasons to believe Starbucks is in a position to grow its earnings per share by double digits in the coming years. The key to the success of the company has been and will continue to be its focus on providing a seamless, convenient purchasing experience for customers.

According to data from eMarketer, approximately 37% of global smartphone users used mobile payment options to shop online and to pay for their subscriptions in 2019. In-store usage of such payment options has been on a secular growth trend as well, driven by the increasing popularity of non-cash transactions. The number of worldwide mobile payment users is projected to surpass 1 billion in 2020 and grow to 1.31 billion in 2023 thanks to the increasing connectivity in both developed and emerging markets. Starbucks, as the leading specialty coffee retailer in the United States, is in a strong position to benefit from this trend. As of October 2019, Starbucks had more than 25 million users in the U.S. who used mobile payment options at least once every six months, and the company was only second to Apple Pay.

Source: eMarketer.

In addition to embracing macroeconomic trends such as the changing ways of how people execute transactions, Starbucks is continuing to innovate with its product offering as well. For instance, the company launched the nitro cold brew in 2018, which was compared to Guinness Stout based on the look and texture of the coffee. In 2019, the Fast Company identified Starbucks as one of the most innovative companies in the world, which is an indication of its commitment to changing the way people consume coffee. This will lead to it generating a high return on investment as premium prices can be charged for novel products.

Further, management plans to increase Starbucks’ share of the global coffee market by expanding out of specialty retail. For instance, the company partnered with Nestle (XSWX:NESN) in May 2018 to form the Global Coffee Alliance, under which Nestle is distributing Starbucks packaged coffee through its regional network. These types of partnerships will enable the company to penetrate densely populated countries such as India, which are vital to the growth story.

The massive investments the company has made in the recent past were not limited to improving the digital experience. As confirmed in the fourth-quarter earnings conference call, Starbucks is investing to provide a more robust experience to in-store customers as well. In addition, the company is looking at opening new stores as a measure of gaining market share, which was evident from the 16% increase in store count in 2019. What is more striking is that comparable sales grew 3% in 2019 on a year-over-year basis, according to company filings. This underpins the strong momentum of the company.

Capital expenditures, however, are projected to decline in the next five years as growth opportunities diminish. This, on the other hand, will enable the company to allocate more cash to repay debt and to improve the balance sheet's health. There are early indications to suggest that Starbucks will go down this path.

Finally, the loyalty program, Starbucks Rewards, is proving to be value accretive as well since it provides consumers with a reason to remain true to the coffee chain despite the growing number of substitutes available. The company is focusing on building an ecosystem around its products, which is the right way to sustain profit margins and remain the leader of the industry on a global scale. Rewarding loyal customers with points and handing out free drinks to celebrate birthdays with them are all part of this plan.

Takeaway

Right now, many investors are paying attention to the latest developments of Covid-19 and are failing to look at the long-term picture of many companies. There is little doubt Starbucks will report disappointing earnings growth in the first half of the year. A two-month-long lockdown in China and the possibility of a nation-wide closure of business activities in the U.S. will lead to a drastic decline in revenue. However, many Western nations will likely follow China’s lead and contain the spread of the virus within a few months. The company has what it takes to survive these trying times and emerge even stronger when things get back to normal.

Ackman was right to short the market a couple of weeks ago, and he will most likely be proven correct once again when Starbucks shares soar as soon as coronavirus fears dissipate. The company's price-earnings ratio has declined to 21 from the recent highs of over 30, and a partial convergence with the five-year average earnings multiple of 29 can be expected in the second half of this year when the global economy recovers.

Disclosure: I do not own any stocks mentioned in this article.

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About the author:

Dilantha De Silva
I am an investment professional with 5-years of experience in financial markets. I specialize in U.S. equities and incorporate a top-down approach to identify developing macro-level trends and the companies that would benefit from such trends. I am a strong believer that the best investment opportunities could be found in under-covered equities.

I currently work with leading financial publications including Refinitiv, Seeking Alpha, ValueWalk, GuruFocus, and TradeGrill to produce investment-related content.

I'm a CFA level 2 candidate and an Associate Member of the Chartered Institute for Securities and Investment (CISI, UK). During my free time, I enjoy reading.

Visit Dilantha De Silva's Website


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Comments

a.xitas
A.xitas premium member - 1 week ago

" Ackman was right to short the market a couple of weeks ago..." He positions himself by shorting the market and then he goes on CNBC all emotional spreading panic and fear all over, saying "hell is coming", thus selling a massive selloff, and you say he was right, like it was a big deal or that he profetize something like that, a fall like the one that happened?!?! Ppppfffff!!!!

Nothing more to add!

https://markets.businessinsider.com/news/stocks/bill-ackman-hedge-profits-billions-coronavirus-tanks-stock-market-economy-2020-3-1029035562

Dilantha De Silva
Dilantha De Silva - 1 week ago    Report SPAM
It doesn't make him incorrect though. Just like I wrote, he was correct to say that, which you are agreeing with. Also, many investors saw it coming but not many had the courage to bet against the market, which Bill Ackman (Trades, Portfolio) did, and he deserves credit for that.

a.xitas
A.xitas premium member - 1 week ago

On that we both agree, that he did it right. Because in the end we are all here in it for the money, and since he made a buttload of it, congrats to him.

But I fundamentally disagree on the way he did it! He could have simply shorted the market and sat in his corner waiting for it to freefall, but no! What he has choosen to do was, being already positioned, to go on CNBC, taking advantage of his position and his status, and started to sell to everyone that was listening to him, the doomsday of the market, making everyone a fool, and encouraging incautious folks to sell on a loss on his benefit. And that Sir, at least to me, as ZERO VALUE, and it is both ethcally and morally despicable!

And no, I'm not a person whose selling, who has lost any money in this recently downturn nor in a pessimistic mood. Quite the opposite, buying good companies at a good price and holding on to them = )

Dilantha De Silva
Dilantha De Silva - 1 week ago    Report SPAM

That's very true. I was shocked myself when he went on live TV to call for a significant decline if the U.S. doesn't shut down everything in a whisk. However, I couldn't let that cast a doubt over his view on Starbucks. I have to agree with him when he bets on the success of this company that will likely remain as the global leader of specialty coffee.

Good to hear that you are buying this market. There are many opportunities because of the short-termism of many market participants. I think we will hear a lot from the likes of Buffett and Klarman in the coming months.

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