- Starbucks has managed through the inflationary environment — so far
- China reopening promises another catalyst
- But at 33x fiscal 2022 earnings per share, the good news looks priced in
Fiscal 2022 (ending September) results from Starbucks (NASDAQ:SBUX) were more impressive than they first appeared. Adjusted earnings per share did decline on a year-over-year basis, but given the myriad challenges facing the company, a modest step-down actually seems like good news.
After all, Starbucks dealt with cost inflation worldwide; higher labor costs; and the impact of lockdowns in China, an increasingly important market for the company. And yet, excluding the benefit of a 53rd week in the year-prior period, adjusted EPS fell less than 5% year-over-year.
It’s a stronger performance than many investors no doubt expected. In the spring, when the market came to believe that inflation was not as “transitory” as hoped, SBUX briefly traded below $70. That level represented a two-year low for the stock.
Now, however, Starbucks stock is nearing $100. And at this level, the concern is simple: all of the good news from fiscal 2022 is priced in, and then some.
Why Starbucks Is Expensive (The Stock, Not Just The Coffee)
Based on FY22 results, SBUX trades at about 33x earnings. Admittedly, Wall Street sees that multiple coming down relatively quickly. Analyst consensus projects EPS growth of 15% in fiscal 2023 and then an acceleration to 18% in fiscal 2024.
Broadly speaking, that outlook does make some sense. There are tailwinds on the way for Starbucks, with the reopening of the China market the most material. In FY22, per data from the company’s annual report, the International segment saw operating profit decline by nearly one-third.
Weakness in China — where Starbucks has some 6,000 stores, more than 30% of its total — seems to account for the totality of that decline. The erosion in the International segment took about 30 cents off adjusted EPS, providing a roughly ten percentage point headwind to EPS.
The hope is that the business will eventually return to its long-term strength, which will not only remove that headwind but add bottom-line growth to the consolidated company.
It’s not as if the environment was all that easy outside of China, either. Starbucks had to deal with inflation and was only able to pass a portion of its higher costs onto customers. In the U.S., pricing boosted full-year revenue by about 8% — but overall, product and distribution costs soared by 18%. That 18% includes some help from the stronger dollar (which also pressured overall revenue and earnings per share).
In short, the bull case for SBUX coming out of FY22 is that it can only get better from here. Starbucks has managed through the worst of the storm.
The Problem With The Bull Case
Again, it’s a case that makes some sense. But it also has two rather significant holes.
The first is that it’s far from guaranteed that FY23 — or FY24 — necessarily will be much better. In China, a new COVID wave is prompting worldwide fears. In the U.S., there’s no real sign of abatement in inflation.
Elsewhere, customers were willing to pay higher prices this year — but this is a breaking point. Should the macroeconomic environment weaken at the same time, Starbucks can quickly go from a regular purchase to a luxury one.
Wage inflation may well continue, given tight employment markets in developed nations. Unionized employees staged a walkout last month.
There’s still a lot that can go wrong here — which gets to the second problem. SBUX looks priced for significant improvement in the external environment. The issue is not so much the backward-looking multiple to FY22 EPS as it is looking ahead. SBUX trades at more than 24x the Street estimate for fiscal 2024, at which point the tailwinds expected over the next two years likely moderate.
It’s not a coincidence that the same analysts coming up with the $4.04 EPS estimate for FY24 are putting an average price target on the stock of about $99. It’s difficult to justify valuation into the triple-digits based, even with strong growth expected over the next two years.
That, in turn, leaves SBUX as a bet on the company outperforming. And while not impossible, it does seem like in a market down 17% so far this year, there are better bets out there.
Disclosure: As of this writing, Vince Martin has no positions in any securities mentioned.