Starbucks (SBUX -0.90%) stock has been under pressure since the company reported its first-quarter fiscal year 2022 (FY22) results on Feb. 1. The stock is down over 25% from its all-time high set in July 2021 and is now hovering just a couple of percentage points off its 52-week low.
Starbucks has a tough road ahead in 2022 and probably 2023 as well. But if we look through a cautiously optimistic lens, we'll quickly find that Starbucks could end up being an excellent core holding for value and income investors alike. Here's what makes Starbucks a value stock worth considering now.
Approaching Starbucks as a long-term investment
Investing in an individual company requires conviction. By buying shares in Starbucks, an investor is basically saying that they think it will outperform the Nasdaq Composite or the S&P 500 over the long term. And for that to happen, Starbucks needs some sort of edge that makes it a better buy than a diversified basket of leading companies.
Any company can post a blowout quarter, sandbag conservative guidance with a beat-and-raise report, or even notch a few good years. But companies that grow into exceptional long-term investments have an entirely different characteristic. That characteristic is the ability to perform during tough times and overcome challenges -- whether those challenges are self-inflicted or a result of macroeconomic disruptions.
A key factor of this characteristic is having a strong brand. Starbucks has a strong brand, and it has spent decades persevering through economic challenges and its own problems. I think it will keep doing that for decades to come.
Wall Street can be quick to point to Starbucks' now-lower FY22 operating margin and earnings per share (EPS) guidance and claim that the company's business is declining. But there's a different and far more meaningful narrative worth considering.
Instead, I would look at Starbucks' Q1 FY22 numbers and its full-year FY21 and FY20 performance and argue that if Starbucks can perform that well during a multi-year period of varying challenges, it must be a great business worth owning. In other words, Starbucks is gritty and excels in clutch situations, and that's the kind of business I want to own for a long time.
Think about it. Starbucks locations depend on discretionary spending and people commuting to work, traveling, and doing things out and about. It's an active audience that is severely impacted by the COVID-19 pandemic. On top of that, Starbucks is now facing a labor shortage and inflation that is increasing its cost of goods. It now pays an average of $17 per hour at its typical U.S. store. Inflation should be crippling its margins, but instead, it's only dinging them. Starbucks is and expects to remain an incredibly profitable and free cash flow (FCF) positive business that continues to return value to shareholders by raising its dividend.
Starbucks finds itself in the heart of the most challenging three-year period since the financial crisis -- at least for its business. And yet, its business is doing exceptionally well.
Anatomy of Starbucks' success
Starbucks falls in the consumer discretionary sector, meaning that demand for its products is going to be more cyclical than for a consumer staple stock like Procter & Gamble. While that's true, you could argue that consumer discretionary companies with strong brands and loyal customers, such as Starbucks or Nike, are better equipped to handle periods of lower demand. That's because these companies have pricing power, which allows them to offset input costs by passing along some of those costs to their customers.
Starbucks raised its prices in the last three months of 2021 and indicated it will do that again in the first three months of 2022. Customers may not appreciate forking over more money for their favorite custom latte. But they may be more willing to pay $0.20 more for a cup of coffee than, let's say, an extra $5,000 for a new car.
Starbucks has one of the best food and drink apps in the U.S., and it shows. The company grew its active members to 26 million in Q1 FY22, which is 21% higher than Q1 FY21, and 70% of customers order via drive-thru or by mobile ordering. And 53% of orders are by Starbucks Rewards Members, an all-time high.
Put another way, Starbucks depends on repeat business from its most loyal customers. Similar to customers that are entrenched in the Apple ecosystem, Starbucks' repeat customers are unlikely to curb their spending too much, even during times of inflation. Impressively, Starbucks' revenue is at an all-time high while its earnings and FCF remain strong.
A pivot from in-store sales to grab-and-go orders via mobile and drive-thru allows Starbucks to make more drinks faster and also encourages higher ticket orders through its mobile app. Starbucks has also done an excellent job increasing its average revenue per transaction as it has improved its food menu and the extent of featured seasonal and iced beverages.
A reasonable valuation
Starbucks expects its margins to fall 200 basis points in FY22 due to inflation, pandemic-induced costs, and training and support costs. But it also forecasts its margins will begin to rebound in FY23 before returning to normal by FY24. Starbucks is guiding for around $32.5 billion to $33 billion in FY22 revenue, up high single digits over a record FY21. But it expects its GAAP EPS to fall between 4% and 6% compared to FY21.
The good news is that Starbucks stock is currently priced below its five-year median price-to-sales, price-to-earnings, and price-to-FCF ratios -- indicating the stock is a good value even given the dampened guidance.
Starbucks also recently raised its quarterly dividend to $0.49 per share, giving it an annual dividend yield of 2%.
An industry-leading company worth buying now
Starbucks is a well-oiled machine with a loyal base, which gives it a strong foundation and keeps its earnings somewhat insulated from ebbs and flows in the broader economy. While it's easy to look at Starbucks' full-year FY22 projections and sell the stock, it's equally easy to see Starbucks' business continue to grow over the long term while staying resilient in the face of short-term challenges. The 2% dividend yield provides the cherry on top of a fundamentally strong business.