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Is Starbucks a ‘Sell’ after Yesterday’s Update?

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On Wednesday, Starbucks (NASDAQ:SBUX) provided an update on how COVID-19 impacted its business. The company expects to lose up to $3.2 billion in sales and $2.2 billion in operating income in the third quarter of fiscal 2020 due to the outbreak. Starbucks’s management expects its SSSG in the US to decline by 40%–45% during the quarter, while China’s SSSG will likely fall by 20%–25%. Management expects the company to report a loss this quarter. Starbucks could post an adjusted loss per share of $0.55–$0.70.

However, management hopes that the SSSG and EPS will improve in the fourth quarter. They expect China’s SSSG to be flat by the end of the fourth quarter. Management projects a decline of 10%–20% for the fiscal year. Moving to the US, management expects the SSSG to decline 10%–20% during the fourth quarter and the fiscal year. Also, Starbucks will likely return to profitability in the fourth quarter. The company could report an adjusted EPS of $0.15–$0.40. For this fiscal year, Starbucks’s management expects the adjusted EPS to be $0.55–$0.95, which is a decline from $2.83 in fiscal 2019.

Starbucks’s stock performance

Investors weren’t impressed by Starbuck’s update. On Wednesday, the stock fell to a low of $78.20 before closing at $79.01. The stock fell 4.1% from the previous day’s closing price. After the fall on Wednesday, the company was trading 10.1% lower YTD. So far, the company has underperformed the broader equity markets this year. The S&P 500 Index has fallen by 1.3% during the same period. McDonald’s (NYSE:MCD) and Dunkin’ Brands (NASDAQ:DNKN) have fallen by 0.9% and 10.6%, respectively. In April, the company reported a mixed third-quarter performance. To learn more, read Starbucks Stock Falls Due to Weaker Fiscal 2020 Outlook.

Starbucks’s valuation multiple

Starbucks’ valuation multiples look expensive. Currently, the company trades at 72.2x analysts’ 2020 EPS expectations of $1.10, at 29.6x analysts’ 2021 EPS expectation of $2.67, and at 24.8x analysts’ 2022 EPS expectation of $3.19. The EPS expectations represent a YoY fall of 61.3% in fiscal 2020. However, the expectations represent an increase of 143.5% and 19.7% in fiscal 2021 and fiscal 2022, respectively.

Analysts recommendations

Analysts expressed mixed views after Starbucks’s update on Wednesday. Jefferies and Piper Sandler raised their target prices. Jefferies increased its target price from $90 to $94, while Piper Sandler raised its target price from $70 to $79. Meanwhile, KeyBanc downgraded the stock from “overweight” to “equal weight.” RBC slashed its target price from $86 to $85.

Overall, Wall Street favors a “hold” rating for the stock. Among the 34 analysts, 61.8% recommend a “hold,” 35.3% recommend a “buy,” and 2.9% recommend a “sell.” As of Wednesday, analysts’ consensus target price was $80.05. The target price represents a 12-month return potential of 1.3%.

My take on Starbucks

On Wednesday, Starbucks’s management stated that 80% of its transactions in US company-owned restaurants were “on-the-go” even before the outbreak. Management wants to improve “on-the-go” customers’ convenience. The company will open Starbucks Pickup locations in dense markets. Starbucks will implement drive-thru and curbside pickup facilities in the suburbs. Also, the company will renovate some of its stores with a separate counter for mobile orders, where customers and delivery couriers can easily pick their orders. These initiatives could drive the company’s SSSG.

Although I think that Starbucks’s long-term growth story is still intact, the company’s stock price will be under pressure for some time. Analysts expect the company’s fiscal 2021 EPS to be lower than its fiscal 2019 EPS. The company owns and operates more than 50% of its restaurants. So, the decline in sales will have a greater impact on the company’s margin. I think that investors should avoid the stock. They will likely get better entry levels later.

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