Starbucks Corp. (SBUX, Financial) has been dealing with a number of headwinds lately, but China appears to be its biggest issue.
Company profile
The Seattle-based company owns and operates a chain of coffee shops where its sell coffee, tea, other drinks as well as food. Just over half its stores are company owned, while the rest are licensed stores. It has operations around the globe in 86 markets. Beverages make up about three-quarters of its sales.
In addition to its namesake brand, it also owns the Teavana, Ethos, Starbucks Reserve and Princi brands. The company also licenses foodservice products, such as ground coffee and ready-to-drink beverages, as part of its Channel Development segment that are sold through other channels outside its coffee shops.
Opportunities and risks
When Starbucks reported its fiscal first-quarter 2024 results at the end of January, there were several issues weighing on it. Chief among them was China, where same-store sales came in below expectations. The company reported that same-store sales in the country rose 10%, but that was well below analysts' expectations of a 16% increase. Transactions jumped 21%, but its average ticket fell 9% as the company became more promotional to help drive traffic.
In the U.S., meanwhile, the company faced backlash from more occasional customers over tweets made by its workers union over the Israel-Hamas war. Starbucks tried to distance itself from comments as they were not its own, but the company said it saw traffic start to decline after the controversy. In response, it is looking to bring less frequent guests into its loyalty program and target them with promotions. Then, not surprisingly, given the war, the company also did see some weakness in stores in the Middle East as well.
Now I would expect the slowdown the company saw from some customers in the U.S to be transitory in nature, and hopefully the war in the Middle East will end soon. The more pressing issue facing Starbucks, though, is China.
China is one of the biggest opportunities and risks facing the company moving forward. The country is not only Starbucks' second-largest market, but also one of its biggest potential growth drivers. Starbucks is looking to grow its store base by 13% this year in China and operate 9,000 stores in the country by 2025, up from around 7,000 today. The company has plenty of white space in the country to grow, and it can also benefit from more frequency, as China is not a high-consumption coffee nation at this point.
For its part, Starbucks is adding more locally relevant beverages to its Chinese locations. It is also trying add more food options to foster daypart expansion and is looking to expand delivery. It is also working on driving down newbuild investment costs.
However, the Chinese economy has been slow to recover coming out of pandemic lockdowns. There has been more tension in recent years between the U.S. and China, which could be impacting the perception of some Chinese consumers to U.S.-based companies.
In addition, Starbucks has been facing increased competition in the country, especially from Luckin Coffee (LKNCY, Financial) following its near collapse after its earlier accounting scandal. The Chinese company has wooed local customers with its inexpensive offerings, often under $2 per cup compared to over $4 for Starbucks, and technology-driven experience with its self-operated stores.
For its part, Starbucks said it is not looking to get into a price war with its rival, instead looking to offer a premium experience.
On its earnings call, the co-CEO of Starbucks China, Ching Wong, said:
“The coffee market is evolving, and going through a transition. It's still early days, and it has not yet fully tiered, right? You see an influx of mass market competitors focus[ed] on fast store expansion and low-price tactics to drive trial. This will shake out over time. And yes, we are operating under an increased promotional environment. We're not interested in entering the price war. We're focusing on capturing high-quality but profitable, sustainable growth, okay? And it is our aim to be the best and lead in the premium market, which Starbucks has pioneered in China 25 years ago. And we will continue to focus on premium experience that is high-quality coffee and human connection. And we have clear strategies to fuel our comp and total growth. …We're going to dial up our beverage and food innovation with robust marketing activations on social media and in-store. We're going to accelerate our digitalization efforts to drive innovations, sales and productivity. We're going to continue our new store expansion infill in existing cities and accelerate new county city entry. We're going to dial up our omnichannel expansion, scale up our membership program and continue to invest in our partners.”
Turning away from China, Starbucks is investing in technology and looking to increase store efficiencies to help drive operating margins. The first quarter showed some nice progress on this front, with the North American operating margins increasing 290 basis points to 21.40%.
The company is also increasing its pace of U.S. openings to 4% growth and adding new menu items to attract customers. It also has plenty of opportunity to grow the brand outside of the U.S. and China.
Valuation
Starbucks trades at about 15.60 times the fiscal year 2024 (ending September) Ebitda consensus of $8.06 billion and about 13.80 times the 2025 Ebitda consensus of $9.13 billion.
From an Ebitdar perspective, it trades at around 13 times 2024 numbers and 11.50 times 2025 numbers.
Revenue is projected to grow 8.10% this fiscal year and 9.90% next year.
For the five years preceding the pandemic, Starbucks typically traded between a 15 and 20 times enterprise value/Ebitda multiple. Notably, growth was often above 10% during this period, but not always, falling to 5% in 2017.
Placing a similar pre-pandemic multiple range on the stock would value it between $102 and $143 based on the 2025 Ebitda consensus. Given where growth is projected, I would probably look toward the middle of the range as a potential target price.
Conclusion
Starbucks valuation is not that demanding as it has often traded in a range of 15 to 20 times Ebitda over the past several years. Meanwhile, it has some nice growth potential with new store openings and a rebound from some recent headwinds. I expect the U.S. to get back on track and the union's comments to be quickly forgotten.
That said, I view China as more of a wild card. Chinese consumers are struggling coming out of the pandemic lockdowns, and the company is seeing a lot of competition from rivals offering cheaper options. Starbucks is used to winning in whatever markets it enters, but despite being in the Chinese market for about 25 years, it is seeing pressure from local upstarts. For example, Cotti Coffee has rapidly expanded in China and ended 2023 with over 6,000 locationsafter launching in only October 2022. That rate of expansion would be unheard of in the U.S., but shows the level of competition the company is dealing with.
Luckin, meanwhile, has started outselling Starbucks in China. This has largely been based on lower prices and more locations, but it has also led with innovation, including with a Moutai-infused alcoholic latte that has been a big hit.
Given these dynamics, I want to watch how Starbucks is performing in China for a few more quarters before jumping in, as it is one of its biggest growth engines with new store openings.
