Starbucks: Solid Results; Debt and Investments Are Risks

Founded in 1985, Starbucks Corp. (SBUX) is a retailer of specialty coffee, with over 30,000 stores in 80 markets. It operates through three segments, including Americas, International, and Channel Development.

I am bearish on SBUX stock. The company reported a very strong fourth-quarter and Fiscal 2021 performance, but its stock is now expensive. There is also the red flag of having negative shareholders equity. SBUX stock has underperformed the market in the past year, with one-year losses of about 4.3%, while its forward dividend yield of 1.96% is higher than the S&P 500’s dividend yield of 1.3%. 

Starbucks Business News

On October 27, 2021, Starbucks announced: that it was making new investments in its partners (employees), continuing its “50-year history and tradition of listening and learning while investing its success back into its people.”

The company announced it would be increasing its pay floor. U.S. hourly partners will average nearly $17 per hour, with a new range of $15-$23 for baristas in Summer 2022.

Other important highlights included: investments in training and recruiting by extending the $200 referral bonuses to help attract new talent, the introduction of “new behind-the-bar equipment and technology” to help make it easier for partners to handcraft beverages and connect with customers, and “innovating the partner and customer experience by teaming retail and support partners together in 20,000 sq. foot Tryer Lab in Seattle for store-partner innovation.”

In mid-November 2021, Starbucks increased its quarterly dividend to $0.49 per share compared to the previous quarterly dividend of $0.45.

Q4 2021 Earnings: Record Revenue

SBUX stock earnings have rebounded from Q3 2020 when they were negative.

Some Fiscal Q4 2021 highlights were an increase of consolidated net revenues to $8.1 billion, a year-over-year increase of 31% (or 22% on a 13-week basis), and an operating income increase to $1.3 billion in Q4 2021 compared to $506 million in Q4 2020. The operating margin of 21.8% expanded from 12.0% in the prior-year period. Note that SBUX’s Q4 ended September 30, 2021.

GAAP earnings per share were $1.49 compared to $0.33 in the prior year. Starbucks announced its intention to commit capital in $20 billion of share repurchases and dividends during the next three years.

On a full-year Fiscal 2021 basis, GAAP earnings per share reported was $3.54 compared to $0.79 in the prior year, consolidated net revenues of $29.1 billion increased 24%, and GAAP operating margin expanded to 16.8% from 6.6% from the prior year.

Fundamentals – Risks

In Q4 2021 and for the Fiscal Year 2021, Starbucks reported an improvement to its gross and operating margins. However, both gross margin and operating margin have been in a long-term decline. More specifically, Starbucks Corp’s gross margin peaked in Fiscal 2016 at 31.6% and now sits at 29%. Its operating margin was 18.1% in Fiscal 2016 and is now 16.2%.

SBUX stock has a high Piotroski F-Score of 8, indicating a very healthy company. In Fiscal Year 2021, the company generated a free cash flow of $4.5 billion, a large increase from the $114.2 million last year. Starbucks has shown predictable revenue and earnings growth.

However, the firm has been issuing new debt. Over the past three years, it issued $5.1 billion of debt. The good news is that interest payments on its debt are well covered by EBIT, with a 10x interest coverage ratio.

I am very concerned about the red flag of negative shareholder equity as of Fiscal Year 2019. Also, efficiency ratios indicate weakness as inventory turnover seems to be stable, but fixed assets turnover and asset turnover have both declined over the past three consecutive years.

Valuation

SBUX stock is relatively overvalued based on its P/E ratio of 28x compared to the U.S. hospitality industry average of 27.1x and based on its PEG ratio of 4.2x.

Wall Street’s Take

Starbucks has a Moderate Buy consensus based on 12 Buys, 10 Holds, and one Sell rating. The average Starbucks price target of $124.70 represents 27.3% upside potential.

Conclusion

SBUX had a strong Fiscal Q4 2021 and full 2021 Fiscal Year, but the stock seems expensive, and there is the red flag of having negative shareholder equity. The large investments announced related to staff will harm profitability.

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