Starbucks (NASDAQ:SBUX) is currently traded at $109.02, nearly its 52-week high, 38.5x LTM P/E, which might have concerned and thereby demotivated investors from getting back in. This article will mainly talk about why I see a significant upside for SBUX.
Starbucks boasts a wide economic moat
Brand intangible assets are scarce and long-lasting, for example, Disney (Disney Stock 2023 Path Forward), and Starbucks. Marketers spend tons of dollars building brand awareness. The Starbucks brand represents an ultimate state of “brand awareness”. It is close to consumers – one can have the first sip in the morning in the same building, grab a quick lunch within your walking distance, or spend a relaxing Sunday afternoon with a cup of coffee and a WiFi-connected computer just a couple of miles away from home. Consumers know the brand so well – the authentic coffee, the selection, the taste, and the service are just exactly what we expect. With brand strength, Starbucks has been very successful in attracting traffic, driving sales of new products, expanding gross margin with its unique pricing power, and growing its footprint globally.
Starbucks enjoys economies of scale, and has been able to maintain its Op margin at 15% – 20% range.
Starbucks investment in Technology and Customer loyalty has fueled the flywheel growth of its business. For instance, 25% of transactions were through mobile orders. Its gift card has $1.6B loaded value as of FY22. This is like interest-free loan to the business.
Starbucks will soon be able to boost its growth in China
As of FY22, Starbucks operated in more than 80 global markets with over 18,000 international stores. Starbucks reported “16% decline in same-store sales in China, Starbucks’ international sales fell 7% to $1.8bn despite a store increase of more than 1,400 outlets in international markets during the period”. Starbucks has an aggressive expansion plan of “opening 9,000 stores in China by 2025”, up from 6,000 stores by FY22.
In my opinion, Starbucks will be able to regain growth in China. I expect Starbucks to be able to reach $5B watermark in 2023 driven by both new stores and same store growth post COVID lockdown. In this section let’s discuss the long-term growth potential of Starbucks in China.
Statista’s data shows China’s Roast Coffee revenue will grow from $10B to $13B during 2022 to 2025. By 2025, Roast Coffee revenue per capita will be $9 in China as compared to $246 in US, and $16 in Asia. I have found Statista’s forecast for China too conservative as it misunderstood the growth drivers of China’s market.
Growth driver #1 – Demographics of Roast Coffee Consumption
As shown in the following figure, Coffee Consumers are concentrated in the segments of consumers below 45 years old. In the past, Consumer’s access to premium roast coffee was very limited in China. As a result, generations above 45 years old were not, and likely won’t become heavy consumers of coffee. For Millennials and Gen Z, they have become loyal consumers of Starbucks, and enjoy social lives centered around premium coffee and casual space. As Starbucks continues to build its presence in greenfield markets in China, I expect a higher per capita coffee consumption in China.
Growth driver #2 – Less Competition in China due to Limited Substituting Products
Starbucks as a premium brand faces even less competition in China simply because of limited substituting products available in the market. Within the Coffee vertical, Starbucks brand is second to none. Even if we look at comparable services from Teahouse (popular and quiet space with delicate decoration and a variety of tea and snack offerings), consumers will have to spend 2-4x of what they would spend at Starbucks to enjoy casual time, WiFi, and social connection.
Growth driver #3 – Economy and Culture Development
If we look at Gen Z, the future mainstream buying power, their life style can be described as follow. I think the economy and culture development in China could be very favorable for Starbucks to grow their business.
– Most disposable income (RMB25 a cup of coffee is very much affordable as compared to their RMB300k-400k annual income (median))
– Fast-paced and digital dominated life, where Gen Z wants to greatly reduce in-person social time (When most of time is spent on digital devices, Gen Z prefers to spend time efficiently on in-person social life, which means a coffee chat is ideal)
– Involution (in a highly competitive professional environment, several cups of coffee are very much needed to boost productivity and commit overtime work)
– Global mind (Gen Z has their global mind, and they embrace global brands and products)
Starbucks Stock is underpriced
My valuation of $132 is based on $4.4 EPS in FY23E, and 30x P/E. This has assumed a material recovery of its China business, and improved cost efficiencies than FY22. Using NTM P/E based valuation is the most conservative way of valuing Starbucks stock as it does not give extra credit to Starbuck’s long-term growth than assigning a relatively fair P/E multiple of 30x.