Global coffee giant Starbucks (NASDAQ:SBUX) and China e-commerce giant Alibaba (NYSE:BABA) are teaming up to increase Starbucks’ presence in China’s booming consumer marketplace. It could end up giving Starbucks stock just the bump it needs.
The deal is wide in scope. It spans everything from integrating a Starbucks virtual store into all of Alibaba’s digital properties, to expanding Starbucks delivery to 2,000 stores in 30 cities by the end of the year. It is also part of a huge push Starbucks is making in China in order to offset slowing growth elsewhere in the world.
Indeed, this deal will provide a big boost to Starbucks’ China operations. As a result, it will also help Starbucks stock, which is 16% off its 2018 highs, get back on track.
But, the time to buy Starbucks was when it dipped big in early July to $48. At that point in time, the risk-reward skewed towards the upside.
Here at $52, the risk-reward on Starbucks stock is neutral. At current prices, growth tailwinds from China are largely neutralized by growth headwinds from competition, and valuation isn’t compelling or over-stretched.
Thus, I think Starbucks can and will head higher from here, but, multi-year stock price appreciation from here will be of the garden variety (10% or lower per year).
Starbucks’ third quarter numbers weren’t that great, despite the headline double beat.
Global comparable sales rose just 1%, versus up 2% in the first half of 2018. This continues what has been a multi-quarter slowdown in comparable sales growth from 5% and up to near zero.
Worse yet, transaction growth was down 2% in the quarter, continuing what has been a multi-quarter trend of declining and decelerating transaction growth. It is nearly impossible for a food and beverage retail chain to sustain growth solely through price hikes, so declining traffic is a big problem.
It is an especially big problem in the U.S., where traffic fell 3% in the third quarter. The operational challenges therein are increased competition from both trend-oriented indie coffee shops and price-oriented fast casual chains building out robust all-day breakfast menus. Together, those two competitive forces are clearly weighing on traffic growth.
On the bright side, the company is still opening a bunch of stores and does have a promising unit growth pipeline in China. Moreover, margins, despite near-term noise, are largely stable in the big picture.
Overall, then, Starbucks third quarter numbers weren’t that great. But, they weren’t all that awful either. Instead, they were just “OK”.
Alibaba Partnership and Starbucks Stock
Starbucks’ big partnership with Alibaba will provide a nice lift to the company’s China growth narrative.
China is arguably the most under-penetrated market for Starbucks. That is why the company’s store base is growing by roughly 15% year-over-year in that region. Comparable sales growth, however, tumbled to down 1% last quarter in China. That is a big fall from the double-digit comparable sales growth rates China was posting just three years ago.
The Alibaba partnership should push China comparable sales growth back in positive territory.
Alibaba is the Amazon (NASDAQ:AMZN) of China, and as such, the company not only commands a huge audience, but also huge consumer respect. Thus, Starbucks virtual stores being integrated across Alibaba’s entire digital portfolio will not only increase Starbucks reach, but also likely boost Starbucks brand value and perception in China.
That will result in collateral benefits for Starbucks, the sum of which will likely drive healthier comparable sales growth going forward.
Starbucks Stock Is Priced Fairly
Despite my bullishness on the Alibaba partnership providing strong tailwinds for Starbucks China, I’m not that bullish on Starbucks stock here and now.
I hated Starbucks stock over the past several years as it bounced between $55 and $65. It was the case of slowing growth converging on a big valuation.
Then, the stock dropped. And, I loved it when it dipped towards $48. At that point, Starbuckshad become a case of overselling creating a compelling valuation.
Now, though, SBUX stock is back to hovering around $52. At these levels, I think Starbucks stock has good upside through China growth. But, competition headwinds elsewhere will keep this stock from being a huge winner.
Overall, I maintain that Starbucks will post mildly positive comparable sales growth over the next several years, and that such mild comparable sales growth in tandem with unit growth and margin stabilization will lead to $3.60 in earnings per share in five years.
A growth-average 20X forward multiple on that implies a four-year forward price target of $72. Discounted back by 10% per year, that equates to a year-end price target of $54 for Starbucks.
Bottom Line on Starbucks Stock
The time to buy the dip on Starbucks stock was when this stock was crashing below $50. Still, at $52, Starbucks stock offers healthy upside in a multi-year window.
As such, I’m not rushing to buy more here. But, I’m not selling either.
As of this writing, Luke Lango was long SBUX and BABA.
