Buying quality is always in style, but in the wake of the Starbucks (NASDAQ: SBUX) stock decline of 15% over the past two months, the coffee giant looks even more worthy of serious consideration by investors. Whether looking for a way to supplement retirement income or looking for some portfolio growth in uncertain times makes no difference.
As a restaurant chain, Starbucks is sensitive to consumers' discretionary spending, so it certainly would not be immune to a severe economic downturn – and signs that such an event is imminent have dominated the headlines of late. (In fact, fears of recession are part of the reason for this fall.) In the long run, however, Starbucks has a clear path to continued growth.
China is still a massive growth opportunity
Although the Starbucks brand is still firmly rooted in the American psyche, it has continued to grow in the United States through new store openings, investments in digital tools such as its order-and-pay loyalty app and menu experimentation. Also benefiting from this is the trend towards more eating on the go; in fact, according to U.S. Census Bureau data, the spending on restaurants this year is set to exceed that of grocery stores for the first time ever.
However, the real wind filling the Starbucks sail is China. There has been a lot of negativity about the economy, especially in light of the ongoing trade war, but in the case of Starbucks & # 39; s plans there, which miss the real story. It's not just about investing in a growing Chinese middle class that can spend more money on coffee. There is also a history of increasing coffee consumption in general. Tea is the caffeine of choice across the Pacific, and Starbucks' work there has only begun to unlock the long-term potential of the signature drink.
Large-scale competition has now emerged to ride the wave. Although only a few years old, Luckin Coffee (NASDAQ: LK) already operates a few hundred million dollars annually; Yum China (NYSE: YUMC) – exclusive licensee of KFC and Pizza Hut in the Middle Kingdom – has also promoted coffee at KFC and launched a new chain called COFFii & JOY. But Starbucks is a premium brand, so what's good for the new coffee makers will be good for it in the end. Despite all concern for the economy, Starbucks & # 39; s China store sales increased 16% year-on-year, and comparable sales (foot traffic plus average transaction size) increased 6% during fiscal third quarter, accelerating from the weak the figures posted over the last couple of years. Not too shabby at all.
Increasing profitability from streamlined operations
This growth increases the bottom line. Operating revenues increased by 8% during the third quarter of the financial year (which ended June 30) as a result of higher numbers of foot traffic – both in China and domestically. Starbucks has made some changes to its business model to help increase that number, including sales of consumer goods business to Nestle (OTC: NSRGY) last year, and more recently, the transition of stores in Thailand from company-operated to full license.
It is early to measure the results of these moves, but free cash flow – a more accurate measure of profitability, calculated as revenue less operating and capital expenditures – is increasing. Pulling $ 7.15 billion Nestle paid Starbucks last year, and its 12-month free cash flow was $ 2.81 billion after Q3 2018, compared to $ 3.37 billion now. This is an increase of 20% year on year. Currently, the stock is valued at 30.0 times the free cash flow (P / FCF) price when it is supported by the lump sum of $ 7.15 billion earned by the Nestle deal.
Putting Money into Work
Given that P / FCF does not scream value, especially for investors who are concerned that an economic downturn is imminent. But keep in mind that Starbucks & # 39; mid- to high-figure single-digit sales growth yields even greater earnings growth. Adjusted earnings per share (single-item back-up) are expected to increase by 16% this year – an increase in share buybacks.
It is also the yield, which currently yields 1.6%. Management has raised the payout by 125% over the past five years. No hikes have been announced yet this year, but the company has a history of annual increases.
At the beginning of August, I wrote that it was time to order some profits on this stock, but the rapid sell-off since then means it's time to start testing the waters again. The world's largest coffee chain is growing, and investors are likely to continue to be rewarded – no matter which direction the economy is heading in the short term.