Starbucks Stock Could Use a Pick-Me-Up After Big Selloff; Is it a Buy?

Key Morningstar Metrics for Starbucks

• Fair Value Estimate: $96.00
• Morningstar Rating: 4 stars
• Morningstar Economic Moat Rating: Wide
• Fair Value Uncertainty: Medium

Starbucks SBUX stock has been on an up-and-down ride for the last five years, and its most recent slide lower may be leaving investors with a bitter aftertaste.

Starbucks’ stock price is down 20% in 2024, with most of the decline after the company’s downbeat earnings report on April 30. Since then, the stock is down roughly 13%. At $76 per share, Starbucks is trading essentially where it was in May 2019.

The culprit for the most recent selloff is an unexpected, significant decline in traffic at Starbucks locations. “Analysts and the company’s management were caught off-guard by the magnitude of the decline, and they’re trying to piece together the likely explanation,” says Morningstar senior equity analyst Sean Dunlop. He cites building pressures on household budgets for lower-income consumers, like student loan payments, higher rents, higher insurance premiums, and inflation. “We’re seeing a pressured low-income consumer shuffle spending toward other priorities,” he explains.

Starbucks, the largest specialty coffee retailer in the world, isn’t alone in hitting a tough patch. Dunlop notes that across the United States, restaurant traffic has declined for almost 24 months. But while there are “plenty of exogenous pressure and variables one could point at, nothing definitive would suggest this should have been the quarter when Starbucks saw its traffic fall off a cliff,” he says.

Starbucks reported fiscal second-quarter sales of $8.56 billion and diluted earnings per share of $0.67, well below Morningstar’s estimates of $9.43 billion in sales and EPS of $0.88. Dunlop says the shortfall was driven predominately by underwhelming comparable store sales. He explains that weekday afternoon sales (which are less habitual and skew toward occasional customers) and weekend traffic were hit particularly hard.

Not at Peak Starbucks

On the positive side, Dunlop notes that Monday-to-Friday morning sales have held up. In addition, the chain’s price/mix, which reflects the typical amount customers spend, rose 4% in the quarter. He expects pressure on sales to continue through fiscal 2025.

However, Dunlop is positive on the longer-term outlook: “We do not think we’ve hit peak Starbucks, and we believe that the firm’s long-term prospects remain extremely salient.” At $76, the stock trades at a 24% discount to its fair value estimate of $96 per share, in 4-star territory. “Shares continue to look cheap, and long-term investors should find the current entry point attractive, though we suggest that investors fasten their seatbelts for the next 18 months,” Dunlop says.

The following are highlights of Sean Dunlop’s outlook for Starbucks and its stock. More of his coverage of Starbucks is available here.

Fair Value Estimate for Starbucks

With its 4-star rating, we believe Starbucks’ stock is undervalued compared with our long-term fair value estimate of $96 per share. As we see it, the biggest near-term issue is that management has largely run out of ways to reverse traffic losses. Its Triple Shot Reinvention plan remains cogent, but throughput-enhancing investments tend to matter less when traffic remains anemic. Menu innovation may help, but it’s unclear whether texture innovation (such as boba) or energy beverages will prove sufficient to defy the gravity of persistent industrywide traffic declines.

Given the difficult trends, we expect pressure on sales to continue through fiscal 2025. To be clear, we believe the firm’s long-term prospects remain eminently possible. Our revised valuation implies a 27 times 2024 P/E ratio and 16 times 2024 EV/EBITDA.

Read more about Starbucks’ fair value estimate.

Economic Moat Rating

Low barriers to entry and minimal switching costs render the restaurant industry very competitive, making it difficult for most operators to develop an economic moat. In our view, Starbucks is one of the few operators under our coverage that boasts a wide moat, thanks to its brand strength—evidenced by pricing power, attractive unit-level economics, successful international replication, and strong results in the retail channel.

Moreover, we believe Starbucks benefits from a durable cost advantage, with its global scale letting it procure commoditized food and paper items at favorable prices. It can leverage technology spending across a larger store base, generating efficiency improvements and cost savings through automated inventory management, scheduling, and a robust omnichannel ordering platform, while a strong loyalty program increases its affinity with core customers. Our wide moat rating assumes the firm can continue to earn positive economic returns for the next 20 years.

Read more about Starbucks’ economic moat.

Financial Strength

We assess Starbucks’ financial strength as sound. The company targets a lease-adjusted debt/EBITDAR of 3 times, consistent with an investment-grade credit rating. Our calculations suggest it should meet this target by the end of fiscal 2024 (2.8 times). The restaurant operator also maintains access to an untapped $3 billion credit facility and a $3 billion commercial paper program, with the option to add an incremental $1 billion in capacity on the former if necessary.

Starbucks’ strong free cash flow conversion (with free cash flow to the firm averaging 9% of sales through 2028) offers the flexibility to invest in technological improvements, new restaurant openings, and menu innovation. We expect the firm to prioritize capital expenditures (estimated at $16.3 billion through 2028), dividends ($13.5 billion), and share repurchases ($18.4 billion), with management targeting a 50% dividend payout ratio in the longer term.

Read more about Starbucks’ financial strength.

Risk and Uncertainty

We assign Starbucks a Medium Uncertainty Rating. The firm remains sensitive to consumer pressure, particularly at the lower end of the income spectrum (as seen in 2007-09), but its position as an affordable luxury may insulate it from minor downturns. Other key uncertainties include input cost inflation and operational risks.

Wage inflation remains a concern, with the firm raising its partner wages to an average of $17 per hour in the summer of 2022. The pace of change remains unprecedented—Starbucks’ announcement of $15 average wages in 2020 was a landmark event just four years ago—and the labor market remains relatively tight (if easing slightly) across the restaurant industry. Broader traction of unionization efforts remains a tail-end risk. Eyes turn to California, where legislators mandated a $20 minimum wage in the restaurant space effective in April 2024—perhaps a harbinger of similar changes in more politically liberal states like Oregon and Illinois.

Read more about Starbucks’ risk and uncertainty.

SBUX Bulls Say

• Starbucks’ “connect” initiative should drive continued adoption of the firm’s loyalty program, materially increasing customer lifetime value and helping drive new user acquisition.
• Ongoing attention to new beverage platforms and menu architecture designed to target specific customer groups should give data-driven Starbucks a durable edge over smaller competitors.
• The firm’s reinvention plan—with investments in partner wages, cold beverage bar technology, and on-demand brewers—should unlock peak transaction volume capacity starting in 2024.

SBUX Bears Say

• Declining traffic within the firm’s base of occasional customers may take multiple quarters to reverse, pressuring comparable store sales and margin expansion initiatives.
• We expect substantially softer (if still attractive) cash-on-cash returns in China, rather than the 50%-70% Starbucks has historically enjoyed, as competition in that country intensifies.
• Shrinking arabica growing regions could drive higher green coffee prices, threatening gross margins (if swallowed by Starbucks) or driving consumers to switch toward cheaper caffeinated alternatives.