Shares of coffee giant Starbucks Corp. (SBUX, Financial) are down close to 20% over the last year as its latest earnings showed inflationary pressures remain. Analysts also forecasted that earnings growth will be low this fiscal year.
As a result of the selloff, shares now trade below their long-term average valuation. The stock is also priced at a discount to its intrinsic value as measured by GuruFocus.
For those with a long-term view of the stock, Starbucks could be attractively priced. Let’s look closer at the company to see why this could be the case.
Earnings highlights
First, let's examine the recent quarterly report. Starbucks reported first-quarter 2022 results on Feb. 1. Revenue grew more than 19% to $8.05 billion, which was $96 million better than what Wall Street analysts had expected. Adjusted earnings per share of 72 cents was an 11-cent, or 18%, increase from the same period a year ago, but missed estimates by 8 cents. This was also well ahead of the company initial guidance for the year of $2.70 to $2.90 in earnings per share.
Starbucks had global comparable sales of 13%, with transactions increasing 10% and average ticket size higher by 3%.
North America and U.S. comparable sales, which were the real driver of growth during the quarter, were up 18%. The number of transactions was higher by 12% and the average ticket grew 6%. Despite higher expenses from commodity prices and employee wages, the operating margin expanded 170 basis points to 18.9%.
Elsewhere, the performance was mixed. International was up 3% as a 5% gain in transactions was reduced slightly by lower ticket size. China was among the worst performers as comparable sales were down 14%. The operating margin contracted 80 basis points to 16% due to an increase in employee wages, investments in the business and higher supply chain costs.
According to Yahoo Finance, analysts expect Starbucks will earn $3.33 in fiscal year 2022, which would be a 3% improvement from 2021.
Takeaways
Starbucks reported strong global comarpable sales. The prior year’s first quarter was weak as sales declined 5%. Much of this was due to a decrease in the number of transactions. However, the first quarter saw average ticket size improve 17%.
The positive news is that Starbucks’ holiday quarter was much better than even two years ago. The fact that ticket size improved at all in the most recent quarter following the high teens growth rate of last year speaks to the demand for the company’s products. The company has a two-year stacked ticket size growth rate of 20%.
The company continued to expand its footprint, including a net new stores of 484 in the first quarter. In total, Starbucks has more than 34,000 stores worldwide, including 15,500 in the U.S. and 5,557 in China.
The biggest headwind to Starbucks is increasing inflationary costs in its products and wage growth. A tight labor market has already led to higher wages in the U.S., but this pressure has also appeared in the international business as well. Leadership guided toward investments of almost $700 million this fiscal year in its global workforce, which is more than triple what it made just two years ago.
Commodity costs are also spiking, which will likely to lead to price increases. Fortunately, Starbucks has incredible brand loyalty, which should help to offset these inflationary pressures. Almost half of U.S. sales, the company’s largest market, are from its loyalty program. These customers often make more purchases and have higher average tickets then non-members. The Starbucks Rewards loyalty program had 26.4 million active users in the U.S., which was up 21% from the previous year.
One last item of note is that the company will be searching for a new CEO as Kevin Johnson retired earlier this month. Howard Schultz will resume his post as CEO on an interim basis while a search takes place for a permanent successor.
Valuation analysis
Starbucks’ shares trade close to $87 at the moment. Using analysts estimates for the year, the stock has a forward price-earnings ratio of just over 26. The company had an average price-earnings ratio of 28.1 over the last decade, implying the stock is trading at a slight discount to its long-term average.
That said, Starbucks has been a growth machine for years, earnings the stock a premium multiple. Earnings for the company have compounded at a rate of 15.3% and 12% over the last five- and 10-year periods. With minimal growth expected for this fiscal year, the market isn’t willing to pay the typical premium multiple for the stock.
However, analysts do expect that higher earnings growth will return next fiscal year in a major way. Consensus estimates call for earnings per share of $3.90 in 2023. This would be a 17.1% improvement from estimates for this year. While forecasts for next year can always change, analysts’ estimates imply a multiple of 22.3 times fiscal year 2023 earnings.
Shares bought today could be trading with a steep discount to the long-term average valuation, offering investors a larger margin of safety and the potential for higher returns if earnings growth occurs as expected.
It is not just on a historical basis that Starbucks looks undervalued. Consider the GF Value Line, which takes historical ratios, past performance and future earnings projections into account.
Starbucks has a GF Value of $113.55, leading to a price-to-GF Value ratio of 0.77. Shares would return nearly 31% if they were to reach the GF Value. This would be before any contributions from the dividend, which yields 2.3% today, were added. Shares of Starbucks are rated as modestly undervalued by GuruFocus.
Final thoughts
Starbucks’ most recent quarterly report was mixed, though the company did surpass the prior year’s revenue and earnings figures by wide margins. The company is experiencing wage and commodity inflation, but hasn’t seen a drop off in demand. In fact, comparable sales are also ahead of where they were prior to the Covid-19 pandemic. The performance in China does bear watching as this is one of Starbucks’ most important growth markets.
Shares have sold off following the release as earnings forecasts for the current fiscal year are barely above what Starbucks produced last year. Still, the stock is trading below its average multiple, especially when using next year’s earnings projections. Starbucks also has immense upside when using the GF Value.
This suggests that long-term investors willing to accept that inflation is going to impact the business in the short term, resulting in low earnings growth this fiscal year, could do well owning shares of Starbucks at the current price.
