Starbucks stock becomes a value play

Valuing a business need not be so focused on theoretical methods and mathematical calculations; while they can be – and oftentimes are – the foundation to beginning to understand the intrinsic value, there are other qualitative factors.

For example, Apple (NASDAQ:AAPL) is a great business and a perfect example of intangible brand value, as customers are relentlessly loyal to the Apple brand and regard it as social currency among peers.

Coca-Cola (NYSE:KO) reported an increase in the price of its products in line with inflation for the first quarter of 2023. Yet, unit sales volumes increased like clockwork, highlighting the ability a business moat allows for navigating challenging pricing markets. Starbucks (NASDAQ:SBUX) shows signs of having similar qualities.

It sells a product that does not inherently need a secret formula yet has made its way to become social currency among society, as people get a certain “first sip feeling.” At the same time, they look at the green medusa.

Navigating inflation successfully

In every industry, there are key performance indicators (KPIs) that analysts and investors consider to get a pulse on business health. In the retail world, where Starbucks falls, comparable store sales growth or decline is typically the first vital sign of where a business is headed.

While Starbucks reported 464 new store openings, including closures in North America and overseas markets, the company also says comparable sales growth of 11%. North America, which brings on board 73% of total revenue, saw 12% comparable sales growth in pace with inflation. International markets saw 7% comparable sales growth, including China’s – a still untapped market – 3% growth.

What is important to note regarding the intangible brand value and social currency Starbucks owns is the 6% increase in the average U.S. ticket price. Increasing comparable sales in pace with inflation while at the same time incrementing the average ticket price speaks to the willingness of the regular Starbucks consumer to stick to the entrenched brand despite inflation dealing its hand.

Over the year, Starbucks chart shows the stock advanced by as much as 70% during a time when the S&P 500 only performed 15%. Beating the market comes from Starbucks being a great business led by capable management and just as much credit to the brand moat the company has developed over its years of servicing customers.

Untapped potential: The numbers

Most Starbucks stores are in the United States; however, the largest Starbucks reserve location was chosen to be built in Hong Kong, China. It is very interesting to note that the U.S. market counts 16,044 stores while China only has 6,243.

This gap would translate to around 20,750 U.S. citizens per every one Starbucks location. In comparison, China would show a much larger ratio of 230,658 citizens per location.

The law of the real estate land dictates that these two ratios are bound to converge to find a medium. In China, Starbucks management is aware of the task they would need to complete to reduce this population ratio to locations, starting with replicating the same brand recognition and social currency status as the U.S. Starbucks increased its North American sites by 3% annually.

In comparison, Chinese locations saw a 10% increase; indeed, increasing demand must justify opening more locations.

Closing down the two ratios between the leading economies would imply massive growth potential for the coffee brand, which may not be reflected in the stock price today.

All told, investors were very pleased to see a total 25% revenue increase for the year, with a 1.3% increase in operating margins to end the quarter at 14.3%. While management only chose to buy back one million shares from the open market, shareholders still saw a 25% increase in earnings per share, when Starbucks ended the quarter reporting $0.74 EPS.

Value disconnect

Starbucks analyst ratings suggest that the stock is fairly valued in today’s market, even assigning a small downside from here. The truth of the matter is that the high estimate target for the company stands at $136 per share, which would make a lot more sense considering that the consensus price is only considering single-digit revenue growth for the future.

Single-digit revenue growth seems conservative when taking into account the potential long-term price increase ability the brand has in North America, as well as the untapped customer base seen in China.

Today’s Starbucks dividend yields near 2%, while historically, the yield has hovered near 1.6%. A high dividend yield compared to historical ranges may imply the stock is undervalued as of today’s prices, a thesis backed by management’s decision to reinvest free cash flow into expansionary activities rather than beginning to return more cash to shareholders.