Starbucks Corp. (SBUX), the iconic and globally ubiquitous purveyor of coffees, recently announced the unexpected departure of its CEO, Kevin Johnson, after five years at the helm. Howard Schultz, who is legendary for not only building the 11-store Starbucks chain of 1987 into a 3,500-store giant by 2000, but also for stepping in to rescue the company in 2008 as it struggled with a dysfunctional culture and a lack of innovation, will once again help Starbucks, at least on a temporary basis, to reinvent itself as it faces new challenges. Starbucks shares rebounded 30x in the decade or so following the 2008 turnaround and the global financial crisis. Are the shares poised for yet another period of enormous returns? Let’s look at how a turnaround investor might think about SBUX stock today.
Sizing Up SBUX Stock
Our first step is to look at the stock price history. While this may sound like the last thing a fundamental investor would consider, we find it exceptionally useful for understanding the current situation.
We see that SBUX stock surged from the split-adjusted 0.53 price at its 1992 IPO to a split-adjusted 38 price by mid-2006, reflecting the impressive global store build-out. We note the 90% price collapse by late 2008, followed by the rebound to peak at just over 120 in mid-2021. The current price is about 27% below that peak. This modest pullback, with the shares still well above nearly their entire history, suggests that the market isn’t particularly worried about the company’s future. A seriously struggling Starbucks stock might trade at 60 or even in the 40 range.
Next, we look at the valuation. We see that the primary driver of SBUX stock has been earnings growth rather than valuation. The shares traded at 15-20x EV/EBITDA in the early 2000s, dipped to 5x in the depths of the 2009 downturn, then stabilized at around 15x for most of the next decade – about where it trades today. All-in, compared to its history and its peers, we might expect SBUX to reasonably trade no higher than this average multiple following a turnaround. Rising interest rates could weigh on this multiple. So, let’s assume a 14x multiple.
What might the fundamentals look like in a post-turnaround scenario? As a reasonable base case, we may assume an 8% sales growth rate, driven by 4% new store growth, 3% same-store sales growth and some contribution from grocery and other distribution channels like Starbucks’ new joint venture with Amazon Go. This growth rate would be comparable to the company’s three-year pre-pandemic rate and would imply about $40 billion in sales for fiscal 2025.
We might model that the company can reach the low end of its goal of 18-19% operating profit margins, implying an EBITDA margin of about 22% in fiscal 2025. This would yield about $8.8 billion of EBITDA in 2025, compared to perhaps $6.5 billion last year.
Our model would assume that Starbucks’ healthy balance sheet remains unchanged, except for the incremental cash flow that accumulates. The company produces prodigious free cash flow, which could total $3.5 billion this year. In fiscal 2025, we estimate it will generate $4.4 billion of free cash flow – or 11% of revenues. This pace is much lower than needed to fund management’s guidance to return $20 billion to shareholders in dividends and buybacks over the next three years, implying that the company would lever up its balance sheet – a departure from its past but clearly within its capabilities.
Using these assumptions, a turned-around Starbucks stock would trade at about 101/share. At only 40% above the current price, this might not be of much interest to a turnaround investor.
Let’s model in more aggressive assumptions.
2 Possible Scenarios for SBUX
Suppose that Starbucks can find 20,000 new locations that are as good as its current 34,000, can lift its same-store sales growth to 4%, and find other growth sources, to produce 10% sales growth. And let’s assume that its sales in China and other complicated markets aren’t crimped, either. This would bring estimated fiscal 2025 sales to about $43 billion.
Let’s also assume that its EBITDA margin can expand to 24%, overcoming likely higher labor, coffee, real estate and other cost inflation through higher pricing, higher value products and efficiency improvements. This would produce EBITDA of $10 billion in fiscal 2025. These profits would generate about $5.7 billion of annual free cash flow.
Using these more optimistic assumptions, the shares would be worth about 129, nearly 80% above the current price. This would be attractive to a turnaround investor.
Somewhere between these two scenarios is how a Starbucks turnaround would likely play out. Investors would want to develop their own models, sensitivities and assumptions, then weigh their confidence and tolerance for risk. They might also compare this potential turnaround in SBUX stock to others in the market – focusing on only the most favorable risk/return ideas.
At the Cabot Turnaround Letter and Cabot Undervalued Stocks Advisor, this type of analysis is what we do every day. Starbucks’ turnaround may be interesting – let us help you sort through the market to find even stronger turnaround stock candidates.
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*This post has been been updated from an original version.