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Stock Analyst Update

Signs of Encouragement From Undervalued Starbucks

We're planning to raise our fair value estimate after comparable-store sales reversal in U.S. and China.

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 Starbucks (SBUX) capped off its fiscal 2018 with signs of encouragement, as comparable-store sales in its two largest markets (U.S. and China) reversed negative trends, alleviating some of the overhang with the stock. While Starbucks still needs to take additional steps to adjust to consumers' evolving views about experience and convenience, we believe the key takeaway for investors is that initiatives like beverage innovation and digital engagement drove results in lieu of discounting, thereby lending support to the brand intangible asset behind our wide moat rating. We're planning to raise our fair value estimate by a little less than 10% to account for greater near-term top-line visibility and a pull-forward of contribution from the Nestle partnership. While we see the shares as only modestly undervalued at current levels, Starbucks remains one of the more intriguing combinations of long-term growth and capital allocation in the restaurant category.

In the U.S., the 4% comp was driven by a 5% increase in average ticket (2 points of pricing and the rest attributed to mix benefits from its cold beverage platform, which also helped to reverse recent weakness in the afternoon daypart) offset by a 1% decrease in transactions, which was an improvement of 2 points versus the 3% decline in the third quarter. China was a menu innovation story as the 1% increase in comps was aided by coffee plus ice cream products, cold foam, and holiday food items. We see a number of levers in both regions that should keep the company aligned with its fiscal 2019 comp guidance for the low end of its longer-term 3%-5% range, including digital engagement (Starbucks Rewards members jumped 15% to 15.3 million in the U.S. during a typically slower recruitment quarter), delivery (including new test markets in the U.S. and the partnership with Alibaba in China), and new store layouts (including drive-thru formats in the U.S. and Star Kitchen locations in Alibaba's Hema stores).

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R.J. Hottovy does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.