Starbucks Won’t Return To Growth Glory, But It’s A Solid Stock Long Term

Shares of Starbucks (NASDAQ:SBUX) are coming back. Their late surge in 2018 has put this coffee chain company in the club of a few consumer stocks that are still posting double-digit gains this year after a massive selloff in the fourth quarter.

Is this resurgence a sign that the company’s frappuccinos and pumpkin-spiced lattes are back in demand or an indication that the company’s turnaround efforts are paying off?

Starbucks (SBUX) - 1-Year Chart

In our view, investors are regaining confidence in Starbucks stock after seeing a rebound in store traffic and improved profitability. In the fiscal fourth quarter, earnings per share came in at $0.62, $0.02 better than expected, and global same-store sales rose by a strong 3% from a year earlier.

U.S. Same-Store Sales Show Promise

To keep things in perspective, this rebound came after many years of dismal performance, especially in the U.S. home market, where Starbucks runs 14,000 stores. U.S. comparable sales growth since 2015 has averaged less than half what it had been in the previous three years.

For some, this weakness was a sign that the company is losing its status as a top, growth-oriented, food retailer that managed to raise its earnings at a 20%-plus rate for many years.

The company reported U.S. same-store sales growth of 4% in the fourth quarter as more customers bought beverages. This was well ahead of the 2.7% growth Wall Street had forecast for the period.

To counter its slowdown in the U.S., Starbucks is closing 150 company-operated stores during the next fiscal year, three times the annual number it historically shutters. In its new turnaround plan, America’s suburbs and China are the two areas that will drive future growth.

The company anticipates that more than 80% of store growth over the next few years will come from drive-through locations, particularly in suburban Middle America and the South.

Time To Look At Dividends Rather Than Growth

Bill Ackman, a billionaire hedge fund manager who accumulated more than $900 million in stock, thinks Starbucks shares have huge upside potential and could double in the next three years.

According to his presentation, China is Starbucks' massive long-term growth opportunity where coffee consumption is rising. With its first-mover advantage, premium positioning and the rollout of delivery services through Alibaba's (NYSE:BABA) Ele.me platform, Starbucks has a competitive advantage in the world’s second-largest economy that is hard to match, Ackman says.

In our view, it will probably be tough for Starbucks to repeat its last decade of performance when its shares returned about 1000%, including dividends, as consumers are becoming more health conscious and shunning sugary drinks.

But Starbucks stock still has a great appeal for long-term investors whose aim is to earn steadily growing income. As the company matures and enters a period of slowing growth, it has been returning more and more cash to investors.

One rarely finds a dividend stock yielding more than 2% that offers such impressive dividend growth. During the past three years, Starbucks delivered about 24% average dividend growth per share and with a median payout ratio of about 42% over the last four years, that pace of cash return doesn't look likely to slow anytime soon.

When it presented its long-term strategic plan in June, Starbucks also announced it would return $25 billion in cash to shareholders in the form of share buybacks and dividends through fiscal year 2020. That represented a $10 billion jump from the cash return target announced in November last year.

Bottom Line

The Street's opinion on whether Starbucks will rebound is divided. The stock might prove to be a great turnaround bet if its growth returns in the U.S. and the China story proves to be as good as some investors believe. Either way, we believe Starbucks is a good long-term investment and investors should take advantage of any future weakness in its share price.

Starbucks shares trade at a very reasonable valuation and with the company's aggressive share-repurchase plan and robust growth in its payout, it offers a good risk-reward equation for the buy-and-hold investors.