Description

Starbucks Corporation (NASDAQ:SBUX) is a roaster, marketer and retailer of coffee. As of October 2016, the Company operated in 75 countries. The Company operates through four segments: Americas, which is inclusive of the United States, Canada, Latin America; China/Asia Pac; Europe, Middle East and Africa, and Channel Development. The Company’s Americas, CAP and EMEA segments include company operated and licensed stores. Its Channel Development segment includes roasted whole bean and ground coffees, Tazo teas, Starbucks and Tazo branded single serve products, a range of ready-to-drink beverages, such as Frappuccino, Starbucks Doubleshot and Starbucks Refreshers beverages and other branded products sold across the world through channels, such as grocery stores, warehouse clubs, specialty retailers, convenience stores and the United States foodservice accounts.

Source: Thomson Reuters

Investment Rationale

SBUX reported their Q1 earnings on Thursday, 25^th January, with non-GAAP EPS of USD0.65, up 25% YoY, beating consensus estimates of USD0.57. However, revenue came in at USD6.07bn, which missed consensus estimates by USD110.00mn. As such, SBUX share price tumbled by 4.2% to USD57.99. While SBUX disappointed with its weak holiday sales in the USA, its China segment grew same store sales by 6% YoY. We believe that the dip has caused SBUX to be undervalued and represents a buying opportunity for the coffee giant.

Recent Price Action: SBUX has been range bound between USD54.00 to USD64.00 since end 2015. Slowing domestic growth has caused the stock to underperform the major indexes. SBUX had been climbing towards the end of 2016 on the back of the tax reform; however, its recent earnings report caused it to dip more than 4%.

Strong momentum in China: SBUX has shown very strong momentum since it started rolling out stores in China. In the latest earnings, the Company reported a 6% growth in same-store sales for China and 30% revenue growth. They also reported entry into seven new cities and over 3,100 stores in China.

Enthusiasm for SBUX seems to remain strong in China. Its new Starbucks Reserve Roastery opened in Shanghai on the 6^th December 2017 and has been performing incredibly well since. SBUX mentioned that the Shanghai Roastery is doing double the average weekly US Starbucks store sales per day after eight weeks of operations.

With China still a distant second when it comes to total revenue; China/Asia Pacific total net revenue came in at USD3.24bn for FY17, while Americas came in at USD15.65bn, we believe that China continues to hold great potential for growth for SBUX.

Rewards Program: SBUX has also been prioritizing their digital footprint by way of their Starbucks Rewards program. We believe that the Rewards program is helps encourage repeat spending by members as well as allow direct marketing through personalized offerings. As such, we find it encouraging that SBUX has been able to add over 1.4mn new members in USA, an increase of 11% YoY, with member spending accounting for over 30% of US company operated sales and Mobile pay representing 11% of US company operated transactions.

Along with the increase in cashless payments, SBUX has also entered into partnerships with different companies like Chase, Tencent, and Alibaba to explore digital payments. Its Shanghai Roastery collaborated with Alibaba’s Taobao app and online marketplace, Tmall, to allow customers to purchase merchandise as well as whole bean coffee to be delivered to their homes. SBUX also partnered with Chase and Visa to launch a Co-branded credit card later in February as well as a stored value card later in April. SBUX mentioned that with only 14mn of their 75mn unique customers signed up, there is great potential to leverage digital technologies to market and establish a more direct relationship.

Valuations:  SBUX closed at USD57.99 and trades at a forward PER of 22.88, with a dividend yield of 2.07%. SBUX 4 year average PER is 28.8 and its 10 year low PER is 17.82. SBUX has total debt of USD3.93bn, with USD2.69bn in Cash and equivalents. SBUX’s annual net income has also been growing consistently. However, it has been slowing in recent years, with revenue only growing 5% and profit decreasing 1% in its recent FY results. However, SBUX pays over 30% effective tax rate, and as such, it should greatly benefit from the tax reform when it reports in FY18. SBUX also recently increased their dividends in the end 2017. It now pays an annual dividend of USD1.20 per share, yielding 2.07% at current prices. This amounts to an annual payout of about USD1.45bn. SBUX was able to generate USD 2.66bn in Free Cash Flow in FY17. As such, we believe that SBUX is undervalued at this price despite the headwinds they are facing.

Technicals: Since August 2017, SBUX has reversed back into the long-term uptrend after finding some strong support at the 52.63 range low. The general uptrend structure of Higher Highs (HH) and Higher lows (HL) followed as the 20 and 60 day moving average propelled price higher. Even after the recent selloff, the general uptrend remains intact.

SBUX Daily chart – Strong hammer rejection off the 57.05 support area

Source:  Bloomberg, PSR

Support 1: 57.05                  Resistance 1: 61.91

Support 2: 55.63                  Resistance 2: 64.00

Red line = 20 period moving average, blue line = 60 period moving average, Green line  = 200 period moving average

The most recent price action saw SBUX plunging on 26 January 2018 where it broke below the 20 and 60 day moving average. At one point, SBUX was down -6.6% on 26 January 2018, but buyers were ready to defend the confluence of support area at the 200-day moving average, 50% Fibonacci retracement level and 57.05 support area showing sign of strength. As a result, a bullish reversal bar (hammer) with surging volume was formed signalling a reversal higher next.

Expect the uptrend to resume next for price to continue forming the series of Higher Highs (HH) and Higher Lows (HL). For this up-leg, buyers should be targeting the 61.91 resistance area followed by 64.00.

The 26 January 2018 hammer’s low of 56.55 could very well be the next higher low point within this uptrend.

Conclusion: We are bullish on SBUX due to 1) China growth, 2) Membership Rewards plan and 3) Historically low valuations. As such, we believe that stock is undervalued and the recent dip represents a buying opportunity.