Starbucks Corporation (NASDAQ:SBUX) is an American multinational chain of coffeehouses and roastery reserves founded in 1971. Starbucks has had a tough financial year in 2024, and has seen declining revenues across both its US as well as global stores. Accelerated investments on the part of management to attract customers, as well as more in-app promotions did not garner enough excitement among consumers as expected, with the economic issues in China further driving down sales. CFO Rachel Ruggeri commented that the resultant decline in traffic hurts both Starbuck's top-line and bottom-line and reiterated that the turnaround process for the iconic brand will take some time. Appointment of former Chipotle CEO Brian Niccol as the new CEO is promising, and management remains committed to returning value to shareholders as much as possible and increased their cash dividend for the 14th year in a row. The new appointment and the resulting earnings for Q1 that beat analyst expectations have provided respite for the stock and it has seen a substantial rise for the first time in a year. Considering the current P/E levels, a long-term investor would benefit from exiting their position at Starbucks to collect a healthy profit and returning to the company at a later date once the turnaround is in full-swing.
Recent Turmoil and Financial AnalysisA tough year for Starbucks led to the ousting of CEO Laxman Narasimhan after only a year and a half, leading to the appointment of Chipotle CEO Brian Niccol as his successor, who achieved tremendous success with the latter. As the largest Coffee chain in the world, Starbucks has struggled with the problem of finding new growth opportunities in a fiercely competitive market.
Starbucks was able to raise revenue for 3 consecutive financial years from FY-2021 (September- August), to FY-2023 by almost 10% on average each year, but profitability for the same period of time has been haphazard. Net Income increased 25% from FY- 22 to FY-'23, but this was after a dip in earnings of 25% from FY-'21 to FY-'22. In FY-'24, the trend has reversed again not only in terms of Net Income but from a Revenue standpoint as well. Total (EPA:TTEF) Revenues grew by only 0.58% for FY-2024, a vast drop in the growth of revenues from 11.5% seen a year earlier.
A second issue facing Starbucks are the costs of doing business. Despite no change in revenues for the three months of Q4 compared with FY '23, there has been no reduction in operating expenses in order to boost earnings, and total operating expenses increased by 1.9% for FY-24.
Despite heightened investments from management to curtail the revenue problem, Q4 results were equally as bad as Q3. Global comparable store sales decreased by 7% for Q4, and consolidated revenues decreased by 3%. There was also a decline in EPS of 25% down from Q4 '23. For the full financial year, global store sales decreased by 2% and EPS by 8% from the year prior, Store sales in the US also decreased by 6% for the year when consensus expected a decrease of 3%-4%, and transactions at stores open for a year minimum decreased by 10%, while sales in China, where Starbucks has a large presence, decreased by 14% for the year, more than consensus expectations of 11%. Management stated that decline was due to a cautious customer environment, the macroeconomic situation in China as well as targeted and accelerated investments like more promotions on the Starbucks app, not improving customer behaviors.
Management also sought to increase investments from the fixed asset side, increasing Property, Plant and Equipment by 17.3% for FY-24 the result of which was the opening of 377 new stores in Q1 FY-25. With same store sales, i.e., sales from existing stores decreasing or remaining flat, these new investments will likely boost Starbucks revenues in the near-future as the company penetrates new regions.
From the liabilities side of the Balance Sheet, Starbucks has a few issues. In the near-term, Starbucks finances are in trouble. The current ratio of 0.75 is worrisome, implying that the company has fewer liquid assets than needed to pay back short-term borrowings. This short-term liquidity issue is more pronounced when analyzing the quick ratio, which removes the effect of inventories, which for a company involved in making and storing coffee beans, is a substantial part of its current asset base. Quick ratio stands at 0.57, further highlighting the liquidity issue faced by the company.
From a long-term lens, the company has substantial debt payments (over a third of all long-term debt) to be made until the close of the decade. Since the end of FY '23, Starbucks has taken on an additional $1 billion dollar note due February 2027 at an effective interest rate of 4.96%. Starbucks has outstanding debt totaling $6.6 billion due before the close of the decade. A second disadvantage is that the credit facility was entered in 2021 prior to the interest rate hikes by the Federal Reserve. Thus, the effective interest for the $6.6 billion credit facility is 3.89% which is much greater than the previous low interest rate environment of the 2010s.
The Liquidity and Debt positions of the company have a few implications: As revenues continue to remain flat or decline, it is important that the company is able to have enough cash on hand in- order to pay dues if quarterly performances continue to underperform. From the debt side, having debt payments puts into question the investor's position in the company. If at all Starbucks is put in a situation of insolvency, the massive debt payments would override any investor claims on assets, leaving equity-holders with nothing.
From a financial management perspective there are a few positives; Net cash from operations for FY-24 is enough to cover long-term debt payments until March 2028 ($4.8 billion due by then). The company has also decreased its current liabilities by 3%. Although this value is small, it is important when considering the broader picture; a small reduction is valuable during times of depressed revenues and tightening liquidity. Management also increased the cash from $0.57 to $0.61; an increase in the dividend for the 14th consecutive year.
Share Price and Industry PerformanceStarbucks has generated poor returns for investors over the last decade, and has only started to improve its performance against the S&P 500 Index in recent months as the new CEO has had some time to set new initiatives in motion and as the company looks to turnaround. The graph below illustrates the performance of Starbucks compared to the index across both 1-year and 5- year periods.
The recent CEO changes coupled with a consistent dividend has allowed Starbucks to perform slightly better against the S&P 500 Index when compared across a Total Return Basis.
Starbucks's P/E ratio of 34.8 is higher than that of the S&P500 Index at 28.77, although this is a worrying sign for an investor; the elevated P/E reflects the market's sentiment that the recent executive change is a positive one, and with the company beating analyst estimates for Q1 FY- 25, there is hope that a turnaround for the company will be in full-swing going into Q2. McDonalds and Chipotle Mexican Grill (NYSE:CMG) are two companies with size and scale in similar scope to Starbucks operating within the Food & Restaurants Industry. McDonald's (NYSE:MCD) with almost twice the market capitalization of Starbucks ($210 billion vs $110 billion) is valued at a P/E of 25.34, and although this P/E is lower than Starbucks's P/E, the stock has actually returned -1.37% over the last year, indicating that investors believe that there are more growth opportunities in Starbucks despite the company's poor margins over the last few quarters.
Chipotle Mexican Grill on the other hand, with a similar market capitalization to Starbucks at $80.8 billion has performed remarkably well, returning 21.12% and a whopping 236.6% over the last 1 year and 5-year periods, over double the returns of the S&P 500 (graph below).
The PEG ratio also illustrates Starbucks current position, being a high level at 3.44. This means that the P/E of Starbucks is 3.44 times its projected earnings growth rate, which is quite high and highlights the primary issue plaguing Starbucks of stagnant revenues and slow growth.
Signs of a Turnaround Q1 FY-25' revenues came in at $9.4 billion, above consensus estimates of $9.31 billion, and the company reported EPS of $0.69/share as compared to consensus estimates of $0.67. Although, these numbers are not massive, it is a signal to the market that the company has instituted positive changes that have shown up in the bottom-line. CEO Brian Niccol also initiated the Back to Starbucks strategy which aims to cut down menu items by 30% and return to the company's long-standing brand image of a cozy coffeehouse that provides patrons with a space to chat with friends or work in peace. Niccol is also reorganizing the leadership group within the company with the goal of hiring former executives of Taco Bell.
Future OutlookAlthough Starbucks is going through a period of turmoil, the bright spot for the company is its strong brand presence and the loyalty it derives from its regular customers. Starbucks has been able to carve an identity for itself as more than a coffeehouse but a place for community and it helped pioneer the brand-building culture that many other global stores adopted.
A positive sign for Starbucks heading into the future is the hiring of former Chipotle CEO Brian Niccol as new CEO of Starbucks. Brian was the architect behind the great performance of Chipotle over the last few years as mentioned previously. At Chipotle, Brian was able to increase profits seven-fold during his six years, for which investors in Chipotle are currently being rewarded. Though this change is a step in the right direction, there are multiple hurdles for Brian to tackle as CEO if he wants to bring growth and renewed public interest in the company after many years.
For a long-term investor, it would be a good time to sell their stake in Starbucks as the company has seen a significant rise in price in the last month, due to the turmoil and the poor performance of the company as compared to its peers. If the investor desires an exposure to Food & Restaurant Companies, it would be better to shift their focus to companies Like Chipotle or even a smaller company like Texas Roadhouse (NASDAQ:TXRH) that has had impressive results over the last few years and is valued at a similar P/E to Starbucks.
For the short-term investor, the elevated P/E levels may turn off an investor looking to make reliable returns in the near-term. The investor can take a gamble on the company at the moment, and if the turnaround goes as expected, the investor can expect to see a rise in price as FY-25 winds down in September. At this point in time, a prudent investor would be better off waiting for a drop in price before entering into a position in Starbucks.
This content was originally published on Gurufocus.com
