Company Reports

Starbucks is the largest specialty coffee chain in the world, generating $36 billion in sales during fiscal 2023. The firm’s attention to premium-quality coffee distinguishes it from chained competitors, alleviating pressure from quick-service peers and at-home consumption while underpinning substantially higher pricing for what has historically been a commoditized product. This positioning looks increasingly important to us moving forward, as vending, single-serve coffee machines, and quick-service restaurants continue to improve at the lower end of the market, and as China approaches a similarly tiered competitive equilibrium.

Wide-moat Starbucks' fiscal second-quarter earnings were very weak, sending shares spiraling (down 12%) in after-hours trading. Given the difficult trends, we expect pressure on sales to continue through fiscal 2025. To be clear, we do not think we've hit peak Starbucks, and we believe that the firm's long-term prospects remain extremely salient. However, the degree of comparable store sales pressure that the firm saw in its most recent quarter was shocking. Global comparable sales fell 4%, with traffic falling 7%. That represents a staggering 9-point comparable sales and 10-point comparable traffic decline over three months. As we digest earnings and sharpen our pencils regarding our 2024 and 2025 forecasts, we expect to lower our $105 fair value estimate by a high-single-digit percentage, with our outlook remaining slightly more constructive than the market reaction. 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.

As we gear up for the release of first-quarter earnings, our top picks in the restaurant industry remain wide-moat McDonald's and wide-moat Starbucks, trading at 14% and 19% discounts to our $312 and $105 fair value estimates, respectively. While industry traffic has been depressed for two years, both brands boast strong digital platforms that allow them to defend transaction frequency without indiscriminate national discounting, and both benefit from scale-driven cost advantages that should allow them to meet the needs of the increasingly value-sensitive consumer without sacrificing financial performance. These are the two most important factors, in our view, that will distinguish the best and worst performers in our industry coverage over the coming years. The industry looks fairly priced in aggregate, trading at a 3% premium to our market-cap weighted fair value estimates. The aggregate figure masks a very bimodal return distribution: Brands like narrow-moat Wingstop (up 108% annually) and wide-moat Chipotle (74%)—which boast strong unit economics and have taken material industry transaction share—have materially outperformed brands like no-moat Wendy's (down 9%) and narrow-moat Papa John's (down 17%), which have not. Those top-performing brands are fully priced, trading at material premiums to our intrinsic valuation (163% and 52%, respectively), suggestive of meaningful execution risk.

Starbucks is the largest specialty coffee chain in the world, generating $36 billion in sales during fiscal 2023. The firm’s attention to premium-quality coffee distinguishes it from chained competitors, alleviating pressure from quick-service peers and at-home consumption while underpinning substantially higher pricing for what has historically been a commoditized product. This positioning looks increasingly important to us moving forward, as vending, single-serve coffee machines, and quick-service restaurants continue to improve at the lower end of the market, and as China approaches a similarly tiered competitive equilibrium.

While wide-moat Starbucks' first-fiscal-quarter results fell short of our own forecasts and FactSet consensus estimates, we view progress toward its cost savings initiatives as an effective offset, resulting in no anticipated change to our $105 fair value estimate. Shares jumped 4% in aftermarket trading after results were better than the market had expected. We continue to view the coffee chain as a winner amid a difficult 2024 backdrop in the industry, with the firm boasting strong store economics, a loyalty program that accounts for 59% of North American sales, and the financial wherewithal to invest through the cycle in a manner that smaller peers cannot. Shares look slightly cheap.

As we survey the U.S. restaurant landscape looking toward 2024, the largest, chained restaurants with durable cost advantages look best positioned to outperform. We expect industry growth to remain low—just 1.3% annually in real terms through 2025, versus a long-term average of 2.5%. The sharp slowdown is predominantly attributable to slowing consumption spending, with pressured U.S. consumers already limiting restaurants’ ability to further increase prices and likely driving an uptick in industry promotional activity.

Starbucks is the largest specialty coffee chain in the world, generating $36 billion in sales during fiscal 2023. The firm’s attention to premium-quality coffee distinguishes it from chained competitors, alleviating pressure from quick-service peers and at-home consumption while underpinning substantially higher pricing for what has historically been a commoditized product. This positioning looks increasingly important to us moving forward, as both vending and single-serve coffee machines continue to improve at the lower end of the market.

Starbucks shares jumped 10% after the wide-moat company posted strong fiscal fourth-quarter results, with $9.4 billion in global sales (up 11%) and $1.06 in EPS comfortably topping our $8.9 billion and $0.95 estimates. With comparable-store sales growth balanced between traffic (up 3%) and pricing (up 4%), driven in part by a swelling loyalty program (approaching 33 million members in the United States, up 14% annually), the firm appears to be firing on all cylinders despite a challenging backdrop. As we digest results, we expect to raise our $103 fair value estimate by a mid-single-digit percentage.

The restaurant industry looks cheap to us for the first time since fall 2022, with the recent market correction creating a buying opportunity for long-term investors. Our coverage trades at a 7% cap-weighted discount to our intrinsic valuations, with wide-moat companies like Yum Brands, Starbucks, and McDonald's looking unusually alluring, each trading at a 10%-12% discount to our respective $139, $103, and $285 fair value estimates. We recognize that slowing same-store sales pose a near-term risk, but believe that large, quick-service operators with scale-driven cost advantages and strong digital touchpoints look poised to capture market share in this dynamic environment. Restaurants are more resilient than many investors realize, with companies that outperform on the basis of "value for the money" like McDonald's and wide-moat Chipotle even posting comparable-store sales growth over the course of the 2007-09 downturn. While we expect consumer spending to slow in 2024, we continue to maintain that the U.S. will avoid an outright recession and believe that investors seeking consumer cyclical exposure would do well to consider turning toward the restaurant industry at current prices.

Starbucks is the largest specialty coffee chain in the world, generating $32 billion in sales during fiscal 2022. The firm’s attention to premium-quality coffee distinguishes it from chained competitors, alleviating pressure from quick-service peers and at-home consumption while underpinning substantially higher pricing for what has historically been a commoditized product. This positioning looks increasingly important to us moving forward, as both vending and single-serve coffee machines continue to improve at the lower end of the market.

Wide-moat Starbucks posted solid third-quarter earnings, with margin leverage leading management to reiterate its 15%-20% adjusted EPS growth target for fiscal 2023, which we view as achievable. The firm's $9.17 billion in sales and $1.00 in adjusted EPS met and edged our $9.17 billion and $0.88 estimates, respectively, with robust (10%) global comparable-store sales growth underpinned by strength in beverage modifiers, a growing food attach rate, incremental delivery sales and a traffic recovery abroad. While we continue to view the firm as well-positioned to navigate the current environment, we struggle to see it achieve its 7%-9% three-year comparable-store sales targets as industry traffic remains pressured (down about 2% over the past three months, per Revenue Management Solutions). On balance, we expect minimal changes to our $104 intrinsic valuation, leaving shares trading in a range we'd consider fairly valued. We're also changing our Morningstar Uncertainty Rating to Medium from High, consistent with our quantitative framework.

Restaurant stocks look expensive as we take the industry's pulse, with names in our coverage trading at a market-cap-weighted 10% premium to our intrinsic valuations. While demand has held up nicely to date, we're seeing weak spots, with persistent declines in traffic and items per check suggesting price-conscious consumers and a more challenging pricing environment to come. Nominal same-store sales growth remains healthy, up around 5.7% industrywide over the past three months (RMS data), but traffic (down 1.4%) and items per check (down 3.7%) remain points of concern. We expect slowing sales momentum into the first half of 2024, resulting in a more promotional environment for the industry and a three- to four-year route to normalized restaurant-level profitability. The industry's bargain bin looks sparse, but we see modest upside in Wendy's and Starbucks shares, which trade at 6% and 2% discounts to our $23 and $104 fair value estimates, respectively.

Starbucks is the largest specialty coffee chain in the world, generating $32 billion in sales during fiscal 2022. The firm’s attention to premium-quality coffee distinguishes it from chained competitors, alleviating pressure from quick-service peers and at-home consumption while underpinning substantially higher pricing for what has historically been a commoditized product. This positioning looks increasingly important to us moving forward, as both vending and single-serve coffee machines continue to improve at the lower end of the market.

We believe that wide-moat Starbucks' fiscal second-quarter results were largely positive, despite a harsh market reaction (shares fell 5%-6% in aftermarket trading), and expect to increase our $103 fair value estimate by a low-single-digit percentage due to time value. As we see it, the market's reaction reflects disappointment in the firm's decision to maintain, rather than raise, its full-year guidance despite a strong quarter (shares have surged 16.5% over the past month).

We believe that prudent adoption of digital ordering, restaurant software, and loyalty programs can yield meaningful benefits for the restaurateurs we cover as well as for astute investors who can identify today's digital leaders. We expect investments in technology to pave the way for food-service establishments to gain share from the grocery channel, settling just north of 55% of U.S. consumer food spending, ahead of our prior 50% estimate, as technology-driven cost savings enable restaurateurs to narrow the value gap with the cheaper grocery channel. The largest chains in our coverage are poised to disproportionately benefit from technology adoption; we forecast their share of total restaurant sales to grow by 200 basis points over the next five years, with wide-moat firms like Chipotle, Starbucks, and Domino's looking particularly well positioned. Investors looking for immediate-term opportunities should consider Domino's and narrow-moat Toast, which trade at roughly 16% and 17% discounts to our $397 and $21.50 intrinsic valuations, though we'd remain eager buyers of leaders like Chipotle and Starbucks at prices below our $1,550 and $103 fair value estimates.

Starbucks is the largest specialty coffee chain in the world, generating $32 billion in sales during fiscal 2022. The firm’s attention to premium-quality coffee distinguishes it from chained competitors, alleviating pressure from quick-service peers and at-home consumption while underpinning substantially higher pricing for what has historically been a commoditized product. This positioning looks increasingly important to us moving forward, as both vending and single-serve coffee machines continue to improve at the lower end of the market.

Wide-moat Starbucks reported fiscal 2023 first-quarter earnings in line with our forecasts, with diluted EPS of $0.74 and consolidated revenue of $8.71 billion close to our $0.73 and $8.73 estimates, respectively. There were, however, regional discrepancies, with results in North America outrunning our expectations on a surprisingly resilient core customer, but with China posing a worse-than-foreseen drag. On a net basis, we expect to lower our $106 fair value estimate by a low-single-digit percentage, leaving shares slightly expensive despite a pullback of similar magnitude in after-market trading. We also plan to raise our Morningstar Uncertainty Rating for Starbucks to High from Medium, consistent with our quantitative methodology.

Starbucks is the largest specialty coffee chain in the world, generating $32 billion in sales during fiscal 2022. The firm’s attention to premium-quality coffee distinguishes it from chained competitors, alleviating pressure from quick-service peers and at-home consumption while underpinning substantially higher pricing for what has historically been a commoditized product. This positioning looks increasingly important to us moving forward, as both vending and single-serve coffee machines continue to improve at the lower end of the market.

Wide-moat Starbucks posted surprisingly resilient fiscal fourth-quarter results, with positive U.S. traffic and a 16% surge in loyalty program membership despite a 10% annual price increase attesting to the strength of its brand. Sales of $8.4 billion healthily outstripped our $8.1 billion forecasts for the quarter, and fiscal 2023 guidance for 10%-12% sales and 15%-20% EPS growth represent a strong vote of confidence in underlying business momentum. While such figures strike us as plausible given the initiatives unveiled at the firm's September 2022 investor day, we remain less constructive regarding the firm's 7%-9% domestic comparable store sales targets in the following years, with incremental growth from cold beverages, drink modifiers, and new drink launches looking unlikely to achieve those benchmarks absent meaningful price increases. In our view, the degree of pricing power restaurants have enjoyed in 2021 and 2022 may not be repeatable in an era of rising borrowing costs, inflationary pressure, and declining asset valuations. We anticipate few changes to our long-term forecasts considering fiscal fourth-quarter results and expect to raise our $104 fair value estimate by a low-single-digit percentage due to time value.

Wide-moat Starbucks announced its intention to sell its Seattle's Best Coffee brand to wide-moat global giant Nestle, a move that makes strategic sense but carries very little in the way of financial ramifications. The brand was acquired in 2003 and generated just shy of $100 million in global sales in 2021, according to Euromonitor—a bit less than 30 basis points of consolidated Starbucks' net revenue and modestly behind its turnover in 2016 ($111 million). Similar consumer food and beverage deals over the past five years have yielded deal multiples in the neighborhood of 2-3 times sales, suggesting that the consideration paid will be financially immaterial for the global coffee chain. We plan to maintain our $104 fair value estimate and Exemplary capital allocation rating for Starbucks and believe management's decision to focus on the core retail business is strategically cogent.