Shares of Starbucks (SBUX) dropped 9% today as investors digested the company’s disappointing update about its expected growth this quarter.
Specifically, management now expects just 1% growth in global same-store sales (locations open at least a year) in the current quarter, below prior expectations for 3% growth.
Additionally, Starbucks announced plans to “optimize” its U.S. store portfolio at an accelerated pace in its 2019 fiscal year. Management plans to close about 150 underperforming stores, which is up from a historical average of around 50 annually.
While 150 store closures represents only around 1% of the company’s total U.S. locations, it sends a signal that America’s coffeehouse market could be more saturated than investors previously believed. Perhaps increasing competition and a greater focus on healthier beverages is hurting Starbucks’ ability to sell many of its high-priced, calorie-heavy drinks.
If so, management could have to reduce its long-term sales and earnings growth targets, just like it did late last year. After all, the U.S. remains the firm’s most important market accounting for over half of total revenue, and sales growth has certainly cooled in recent quarters.
Adding to investors’ angst, same-store sales growth in China, a key long-term growth market that accounts for approximately 13% of company-wide sales today, is expected to be about flat this quarter, decelerating significantly from its 8% pace of growth just several quarters ago.
Management blamed the shift primarily on the acceleration of mobile ordering and third-party delivery services in China. Starbucks is working with a large tech company on a delivery partnership that it expects to be in place by the end of the calendar year.
The company’s outlook on profitability and revenue growth in China has not changed, and management still expects Starbucks to generate at least 20% revenue growth in China this year thanks to new store openings.
Clarity can be hard to achieve in these situations, and investors hate uncertainty – especially when it involves a growth stock with fairly high expectations. The “shoot first, ask questions later” approach tends to drive short-term performance as long-term growth expectations adjust.
Prior to the stock’s drop, shares of Starbucks traded at a forward P/E ratio of 22.1, well above the S&P 500’s multiple near 16.5. The stock’s premium valuation reflected investors’ expectations for strong and sustained long-term growth.
This week’s news clearly rattled the confidence behind Starbucks’ growth story. If Starbucks’ growth runway isn’t as long as investors thought, the stock no longer deserves such a rich multiple.
On the bright side, Starbucks is accelerating its return of cash to shareholders and announced a 20% increase to its regular quarterly dividend, marking its eighth annual increase. The stock’s forward dividend yield now sits at 2.8%, an all-time high.
Management also remains confident in their long-term growth targets of:
- 3% to 5% global same-store comps
- High single-digit revenue growth
- Double-digit earnings and free cash flow per share growth
So how should dividend growth investors handle Starbucks going forward? The bad news is that the stock still trades at a fairly lofty forward P/E ratio of 20.1, even after its large decline today.
If the company’s same-store sales growth cannot return to management’s long-term guidance, the stock’s valuation premium will likely continue to contract. Starbucks’ dividend will remain on solid ground and should be able to continue increasing, but it will take time for the stock to “grow into” its current multiple.
On the other hand, it is possible that the headwinds facing Starbucks are transitory in nature. From delivery issues in China to the company’s recent PR disaster in Philadelphia, there have been several challenges that seem unlikely to be remembered a year from now. Furthermore, the company continues making significant progress growing its number of digital relationships with customers, which is expected to strengthen its U.S. business over time.
If I held Starbucks as part of a well-diversified portfolio, I would stay the course. Volatility is to be expected with growth-focused companies and one or two quarters of deceleration doesn’t necessarily make a trend. However, given the stock’s still-steep forward P/E ratio near 20, I would prefer to have a more conservative position size.