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Starbucks is Luckin’ Out

By Bradley Freeman - May 11, 2020 at 10:46PM

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Why the Future Remains So Bright for Starbucks.

In times of systematic uncertainty, going with the best in breed can help mitigate an investor's downside. Ubiquitous companies like Nike or Apple are generally better equipped to cut through turbulence than smaller organizations operating in the same space. Scale offers unmatched flexibility on both negotiating with suppliers as well as bolstering revenue. Generally speaking, size helps foster durability.

Starbucks (SBUX -1.17%), the largest coffee company in the world, fits seamlessly into this description. Their massive 30,000+ store footprint offers the Seattle-based coffee company unmatched pricing flexibility compared to smaller competition. Simply put, the massive organization can afford to make less money per cup than individual shops with less volume. The result: a small black coffee at Starbucks costs a fraction of what it does at my favorite local shop. This value proposition for the giant chain translates into intriguing company fundamentals.

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Up until the coronavirus pandemic, Starbucks delivered consistently strong earnings results. With CEO Kevin Johnson and most of the market withdrawing 2020 guidance, it is imperative to understand how Starbucks entered the pandemic, and how they should rebound. Piecing together all available information in our current times of chaos is vital to making a calm, rational decision.

Valuation Looks Good

Starbucks trades at roughly 25 times their 2019 pre-Coronavirus price to earnings. From a shareholder perspective, the famous coffee chain currently sells for under 8 times their combined 2019 dividend plus buyback. These modest multiples become seat-grabbingly compelling when considering 7% revenue growth that same year, roughly twice the S&P 500. This sales premium should be met with higher earnings and cash flow multiples. That was the case before the pandemic stormed into the picture.

Early Signs of Recovery

Coronavirus rapidly shuttered much of our economy, with Starbucks locations included. While this led to a 40% haircut in their stock price, the organization is better positioned than most. Kevin Johnson announced a plan to have 85% of American stores open by the end of the week. This will coincide with different store rules, and heightened health precautions. Regardless, that is fantastic news and the relative speed with which Starbucks can restart operations will make the cash burn period comparatively muted.

It is not just the United States showing signs of life for Starbucks. China is recovering as well. While the pandemic inflicted a 50% hit on the company's largest growth market, brighter days are ahead. Johnson reported a strong Chinese sales recovery in recent weeks, thanks to an easing of the pandemic conditions. This is nice, but I would take it a step further. Starbucks will not only recover lost sales in China but has a future there as bright as ever. Why?

Easier Competition Going Forward

Starbucks' global prospects are being helped by fraud from a competing Chinese coffee chain. In recent weeks, reports surfaced on a Luckin Coffee accounting scandal, where they allegedly vastly overstated sales numbers and earnings. Luckin is, or was, considered the biggest competitive threat to Starbucks in China. U.S equity liquidity, a large source of Luckin's funding, is unavailable to the company as a result. 

The troubling combination of legal issues plus funding concerns will cripple Luckin's ability to compete with Starbucks in China, paving the way for even more market share. As a result, Kevin Johnson's company will accelerate its already strong gains as Chinese consumers continue to shift from tea to coffee.

Coronavirus left few stocks immune to the resulting economic pain. Sure, we can consider this to be the new normal and chase companies aided like Amazon or Netflix. That seems misguided to me, and instead Starbucks looks to have better value longer term. I do not know when normalcy will return, and nobody does. Regardless, I am hopeful that arenas, restaurants and yes, coffee shops will again be full.

 

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Bradley Freeman has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon, Apple, Luckin Coffee Inc., Netflix, Nike, and Starbucks and recommends the following options: short January 2022 $1940 calls on Amazon and long January 2022 $1920 calls on Amazon. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Starbucks Corporation Stock Quote
Starbucks Corporation
SBUX
$88.35 (-1.17%) $-1.05
Luckin Coffee Inc. Stock Quote
Luckin Coffee Inc.
LKNC.Y
$14.50 (-1.96%) $0.29

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