Starbucks's (NASDAQ:SBUX) stock price had not surpassed its all-time high of $126 for over three years. After the financial crisis, it had appealing upside volatility and significant price appreciation. Nonetheless, the last few years haven't been as good as in the past, and the stock has experienced a drawdown of roughly -45%.
Source: TradingView
Over the past months, the future price of coffee has skyrocketed, jumping to historical levels. However, Starbucks's stock has behaved extraordinarily since August, with the share price appreciating approximately 47% and standing at $112, just 12.5% away from its all-time high level.
Challenging Backdrop Has Created a New Strategy
It is not a secret that Starbucks has been struggling with comparable growth. In the past four earnings releases, the company has experienced negative comp growth in all geographies, but especially in China, where competition from fast-growing rivals such as Luckin Coffee (OTC:LKNCY) has affected its market share.In the US, high inflation has caused consumers to reduce traffic and seek lower-priced alternatives, such as Dutch Bros (NYSE:BROS). This has made Starbucks rely on promotions to mitigate the revenue loss, which has reduced gross margins.
Amid this backdrop, the coffee chain has introduced the "Back to Starbucks" strategy, which consists of fundamental changes such as simplifying its menu and reducing its options by 30%. At the same time, they plan to reduce discount-driven offers and have more consistent pricing. Lastly, it is launching a smaller store format for its US expansion.
Stock Price Recovery
Two main events have explained the strong performance over the past months.Earnings Display a Slight Change in Trajectory
For Q1 FY25, Starbucks reported a -4% annual decline in its comparable sales. In the US, the drop was -4%, and in China, it was -6%. Although these declines are not favorable, they set a change in trajectory, as in the previous quarters, the yearly drop was higher at -7%, of which China had a decrease of -14%.Simultaneously, the company's operating margin contracted 380 bps to 11.9%, which was partly explained by the elimination of extra charges for non-dairy milk additions on beverages. The elimination was motivated by bringing the pricing architecture to be more transparent for customers, and it was an action that competitors such as Dutch Bros followed immediately.
"We believe it's the fundamental change in strategy we needed to solve our underlying issues, restore confidence in our brand, and return the business to sustainable long-term growth. While we're only one quarter into our turnaround, we're moving quickly to act on the Back to Starbucks efforts, and to date, we've seen a positive response". Brian Niccol, CEO
Strong Balance Sheet to Pay Dividends
Although Starbucks's equity has been negative since 2019, thanks to aggressive share repurchases and dividends, the company has solid liquidity ratios, with an interest coverage ratio of 8.66x and a diversified debt maturity schedule on its $15.7 billion outstanding debt, with 73% of the debt maturing after 2028. At the same time, their quarterly dividend was recently increased by 7% to $0.61 while having a conservative dividend payout ratio of 0.88, which makes the dividend payments out of risk despite the backdrop."Our balance sheet remains strong, and we remain committed to our triple B plus credit rating. We continue to prioritize shareholder value through dividends, providing a predictable return of capital while we turn around our business." CFO Rachel Ruggeri
Coffee Prices Soaring
One obvious external risk of the company is the soaring coffee prices that have appreciated more than 120% in a year. Yet, during the most recent earnings call, management mentioned that coffee purchases are just a small percentage of their distribution costs, and although this affects the bottom line, the company is not willing to entirely pass through the excess cost to consumers amid the backdrop."As a reminder, our total cost of green coffee is typically limited to 10% to 15% of our product and distribution costs. In addition to the direct coffee pressure on EPS I just mentioned, C price volatility also impacts our channel development segment and in a more meaningful way. Although we can pass this cost to our business partners, higher prices to an already pressured consumers will likely impact our segment volumes and ultimate revenue and profitability." CFO Rachel Ruggeri
Valuation
SBUX Data by GuruFocus
Based on the current dividend yield and enterprise value to EBITDA, the stock price of Starbucks looks fairly valued compared to its five-year history. The median dividend yield of Starbucks has been 2.07%, which is close to the actual yield of 2.06%. Simultaneously, the current EV-to-EBITDA of 22x sits close to the median of 23.5x. Finally, peer Dutch Bros trades at a higher multiple of 52.7x EV-to-EBITDA, which could be justified by a much higher comparable growth of 6.9% YoY in Q4.
Conclusion
Ultimately, Starbucks chains are a great business model that has been constantly able to replicate and aggressively open new locations worldwide. The change in strategy would likely take some time for the financials to see a full effect and experience growth in its comparable growth rates. Yet, with the shares sitting fairly valued compared to their history, there is an opportunity to anticipate a recovery and be bullish on the stock at this price.This content was originally published on Gurufocus.com
