Amid the market rout in recent months that has crushed high-multiple, fast-growing tech stocks, a blue-chip ticker like Starbucks (SBUX 0.93%) has found itself in the chaos. Shares are down 35% this year alone, causing many shareholders to consider running for the exits.
However, I think the pessimism presents shrewd investors with a buying opportunity in this household name. Here are three reasons Starbucks makes for a solid investment right now.
Strong brand as a competitive advantage
For starters, Starbucks possesses a powerful competitive advantage that is intangible in nature, making it extremely difficult (or impossible) for a rival to replicate. I'm talking about the company's globally recognized brand. According to Piper Sandler's spring 2022 Taking Stock With Teens survey, Starbucks was in the top three in the restaurant category among the Gen Z demographic. This is a lucrative spot to be in because these younger consumers have the potential to be lifelong Starbucks customers.
Starbucks' gross margin of 27.9% over the trailing 12-month period indicates consumers' propensity to pay up for what they deem is a premium food and beverage product. A margin this high gives the business leeway when it comes to absorbing higher input costs while still maintaining profitability.
Throughout the inflationary environment that the U.S. has been enduring, Starbucks has consistently been able to raise prices with no adverse effect on demand. "Over the last year, we raised prices several times to address increasing inflationary pressures," founder and interim CEO Howard Schultz said on the second-quarter 2022 earnings call. "Yet, we experienced negligible customer attrition, once again demonstrating the elasticity of demand for Starbucks coffee."
Legendary investor Warren Buffett thinks that the most telling sign of a quality enterprise is the presence of pricing power. Starbucks checks the box in this category.
Runway to open more stores
Despite Starbucks' ubiquity today, with 34,630 stores worldwide, management believes that there is ample opportunity to continue growing the retail footprint. By 2030, executives see there being 55,000 Starbucks locations in 100 different markets. That's still a long expansion runway.
The U.S., which represents 67% of overall revenue, is seeing record levels of demand, causing Schultz to suspend share repurchases in order to direct capital investment toward accelerating store openings, with a focus on building drive-thrus. Although there are currently 15,544 stores in the U.S., experimenting with new methods of serving customers in ways most convenient for them will boost Starbucks' already dominant position.
Image source: Getty Images.
China, unsurprisingly, will be the biggest growth engine during the rest of the decade. Starbucks will eclipse 6,000 stores in the country by the end of this fiscal year. Populating massive urban areas with smaller, digitally enabled outlets will help drive sales growth. Rachel Ruggeri, the company's CFO, says the executives "remain very optimistic for our future growth in China."
A larger store footprint will allow the company to leverage its expenses as revenue rises, thus supporting greater levels of profitability over time. Coffee is a lucrative business to be in because it is universally loved and lends itself to repeat purchase behavior, which puts Starbucks in an advantageous position.
The valuation is attractive
With the stock's decline in 2022, shares are trading hands at a compelling price-to-earnings (P/E) ratio of just over 20. Not only is this near the lowest level that Starbucks has sold for in the past decade, but the stock is also at a slight discount to the S&P 500's P/E ratio of 21. Given the strong brand and growth opportunity, a valid argument can be made that Starbucks is a better business than the average company out there, warranting a higher valuation than the S&P 500.
Wall Street consensus analyst estimates call for earnings per share to increase 12.2% per year from fiscal 2021 through fiscal 2026. Couple this with a deservedly higher multiple, and the potential for market-beating returns is definitely there.
The beauty of owning Starbucks shares is that this is a forever type of investment. Serving consumers with premium-priced coffee and food doesn't really invite much technological disruption, and the slow-changing nature of the industry benefits the business and its durability over time.
