Why Changes at Starbucks (SBUX) Could Spell Big Profits

In Starbucks (SBUX) stores, sales are down, as is foot traffic.

Billionaire activist Nelson Peltz decided it was time for a change as did Elliot Management.

Unsurprisingly, the board pushed out CEO Laxman Narasimhan in favor of Brian Niccol from Chipotle Mexican Grill (CMG).

The news sent shares soaring 25% in a single day, enough that Pelz decided to dump his shares.

According to our TrackStar data, financial pros felt the urge to read the news as search volume skyrocketed on Tuesday.

Everyone is abuzz with the addition of Niccol, who drove operational improvements and digital engagement at Chipotle.

Yet, with the recent rise in shares and a recession looming, is this the best time to jump into the stock?

Starbucks’ Business

Starbucks, with its sprawling network of 39,000+ stores across 86 markets, dominates the specialty coffee scene. This Seattle-born behemoth has mastered the art of turning beans into billions.

Step into a Starbucks, and you’re greeted by more than just the aroma of freshly brewed coffee. The menu boasts an array of drinks, snacks, and merch that keep customers coming back. 

With 33.8 million active U.S. Rewards members, Starbucks has loyalty down to a science.

Starbucks segments its business into three distinct areas:

• North America (75% of total revenues) – The home turf, where lattes and Frappuccinos fuel millions daily
• International (20% of total revenues) – Global domination, one flat white at a time
• Channel Development (5% of total revenues) – Bringing Starbucks to your pantry and local grocery store

In Q3, global sales dipped 3%, with the U.S. down 2% and international markets sliding 7%.

However, management highlighted green shoots in the U.S. business driven by the three-part plan outlined last quarter:

1. Unlock demand by focusing on improvements in store operations and elevating experiences for customers.
2. Attract new customers and drive transaction growth with new products
3. Reach new customers and demonstrate commitment to value.

Meanwhile, in the high-stakes Chinese market, Starbucks is playing chess while others play checkers. This includes:

• Expand aggressively: They’ve pushed into 900+ county cities, with new stores boasting cash-on-cash returns of up to 70%.
• Double down on loyalty: Starbucks Rewards members in China hit a record 22 million, with a new diamond tier to pamper big spenders.
• Embrace innovation: The company is exploring strategic partnerships to accelerate growth and stay ahead of local competitors.

Financials

Source: Stock Analysis

Like many food and beverage chains, Starbucks faces its lowest revenue growth since the pandemic.

After seeing sales expand by double digits, sales have slipped the last two quarters. While this hasn’t materially impacted margins, a protracted decline could lead to higher inefficiencies.

That’s why the company plans to focus on improving its current operations.

Starbucks’ total debt sits at $25.3 billion, with only $3.4 billion in cash on hand.

With $6.5 billion in annual cash generated from operations plus $2.7 billion in CAPEX, management can comfortably service its debt while repurchasing shares and paying its 3.0% dividend.

Valuation

Source: Seeking Alpha

With Starbucks’ recent spike in share price, the company now trades at 21.6x earnings and 13.4x cash flow. That’s still cheaper than every other peer listed here, with McDonald’s as the closest competitor at 23.6x and 20.1x, respectively.

If Niccol can put the company back in growth mode, then this stock becomes even cheaper.

Growth

Source: Seeking Alpha

Of the group, Starbucks’ recent revenue gains are in line with McDonald’s and Domino’s Pizza (DPZ).

However, if you look at Chipotle’s numbers, you’ll see why everyone is giddy over Niccol’s hire.

Profitability

Source: Seeking Alpha

Starbucks certainly has room to improve its margins.

Its EBIT is the lowest of the group next to Shake Shack (SHAK), as is its net income and free cash flow margins.

Our Opinion 10/10

With a 3% dividend, a positive catalyst, and a great business, we believe Starbucks is still cheap.

Niccol knows how to rebuild premium brands. And should the decline in consumer spending be temporary, he’ll get an additional tailwind in the back half of 2024.

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