Buy Starbucks Stock. Shares Could Be Ready to Run.

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A sequel is seldom as good as the original, and the less said about the sequels to sequels, the better. Howard Schultz, the former CEO who recently returned to helm

Starbucks
,
may be the exception—offering investors a reason to buy the beaten-down stock.

Shares of the Seattle-based company have dropped 36% in 2022, on pace for its worst year since 2008. Starbucks (ticker: SBUX) has been hurt by the possibility of slowing growth for its rewards program and unionization efforts at its stores, as well as China’s economic slowdown and the U.S.’s soaring inflation, which have added to costs. The possibility of a recession only adds to the list of worries investors have about the company’s prospects.

Enter Schultz, who returns to Starbucks just four years after leaving. Schultz purchased the company in 1987 and created what we know as the modern Starbucks, masterminding its rise from a corner coffeehouse to an international chain with a coffeehouse seemingly on nearly every corner. From 1992, the company’s first year as a public company, to 2000, the end of his first stint at the helm, the stock returned 37.7% annually, compared with the

S&P 500
index’s 19.7%.

Schultz came back as CEO in January 2008, and the stock returned an annualized 18.2% through his departure in June 2018, outpacing the S&P 500’s 8.9% return. Now Schultz is back again—he announced his return in April—and ready to tackle Starbucks’ problems head-on.

The last time Schultz returned, he slashed costs to get the company through the 2007-09 recession. Starbucks could use his budgeting skills yet again. For its fiscal year 2022, which ends in September, the company is expected to see its costs of sales, which include wages and commodities like coffee beans, rise 30%. In May, the company said it would see $200 million in additional expenses from investments in wages, employee training, and technology within the next several months, which analysts say will amount to more than $500 million in added annual costs in 2023.

Still, this isn’t 2008. Costs aren’t going to come down, but the worst of the increases should be past. And Schultz, for his part, knows he needs to be willing to invest for growth even if it means looking past some near-term pain.

Schultz should get some help along the way. The good news starts in China, which has been a trouble spot for Starbucks. While same-store sales in the world’s second-largest economy fell 23% year over year during the second quarter, China lifted some of its Covid-related restrictions in May. Starbucks’ sales in the country—which accounted for $4 billion, or 12% of its total sales, over the past 12 months—should start to improve and might even return to pre-Covid levels by the first half of 2023.

“China was a mess, and all of a sudden you have a China reopen story,” says Stephanie Link, chief investment strategist at Hightower Advisors, which owns the stock.

Starbucks should also continue to see a recovery in the U.S. Store traffic remains about 10% below prepandemic levels, according to Evercore ISI estimates, and continued improvement should help sales in the U.S., lifting overall revenue to an estimated $32.3 billion in 2022. Starbucks also highlighted its “consistent pricing power” on its second-quarter conference call in May, which has allowed it to raise profits in North America. In total, analysts expect Starbucks’ sales to grow another 10%, to $35.6 billion, in 2023.

But growing sales won’t help much if Starbucks can’t turn more of its revenue into profits. Analysts expect the operating margin to rise to 15.8% in 2023 from 14.8% in 2022. That would put it on a path back to 2021 levels, when margins were around 18%, as costs should start to decelerate, even as the company continues to spend on growth. “Expensed investment will be relatively modest when compared with this year’s…inflation impact to U.S. margins,” writes Evercore analyst David Palmer.

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Earnings per share are expected to fall to $2.89, down 11% from $3.24 in 2021, but should increase 20% in 2023, to $3.47. And if fixed costs remain mostly in check, EPS could grow 15% annually to $4.38 by 2025.

If Starbucks can hit those numbers, the stock could be, if not a bargain, at least quite compelling at current valuations. It trades at just over 22 times 12-month forward earnings, near its lowest level since 2020 and below its five-year average of 27.3 times. Closing that gap to 25 times 2024 earnings would put the stock at $98, up 30% from Thursday’s close of $75.20. “It’s pretty cheap compared with where it’s traded historically,” says Credit Suisse analyst Lauren Silberman, who calls 25 a “fair” valuation and has an Outperform rating and a $103 price target on the stock.

Whether those gains materialize depends on Schultz. He needs to make immediate investments—like spending on training baristas for new store configurations—while continuing to grow the Starbucks Rewards program, whose members spend two to three times as much as nonmembers each year. Silberman, for one, says membership could hit more than 70 million in the next few years, up from just under 30 million now. Schultz will get a chance to lay all this out at Starbucks’ investor day on Sept. 13, when the company should provide updated long-term guidance.

That could really provide a jolt for the stock.

Write to Jacob Sonenshine at [email protected]