Why Starbucks Shares Are Attractive Even With Slowing Growth

After hitting a multiyear high of almost $65 in May of 2017, since then, Starbucks shares have fallen 17%. During the past one year when the S&P 500 Index gained about 18%, Starbucks’ stock has been stuck in the mud, down about 2%.

The main catalyst for this poor showing is sales growth at its 14,000 plus stores in the U.S., which has stalled at a time when the world’s largest economy is firing on all cylinders. This decline occurs even as American consumers have more money to spend on higher-end hot and cold beverages. This year, with improving consumer confidence and stronger wage growth many other food chains have posted impressive earnings growth.

Unfortunately for shareholders, in contrast, Starbucks has hit a roadblock. There’s nothing that seems to be working for the company, at least in the short-run. Its global comparable-store sales growth during the fiscal 2018 third-quarter was a meager 1%, in line with the company’s disappointing forecast, announced in June.

For some, this weakness is a sign that the company is losing its status as a top, growth-oriented, food-retailer that managed to raise its earnings at a 20%-plus rate for many years. The company’s turnaround plan also shows that the days of easy growth are over as there isn’t much juice left to be squeezed from the U.S. urban centers that once powered the company’s remarkable expansion.

This past June, Starbucks announced it would be closing 150 company-operated stores during the next fiscal year, three times the annual number it historically shutters. In its new plan, America’s suburbs and the world’s second-largest economy, China, are the two areas that will drive future growth.

The company anticipates that more than 80% of store growth over the next few years will come from drive-through locations, particularly in suburban middle America and the South. Starbucks has a number of initiatives in the works to turn around weak sales, including offering a more diverse range of cold beverages, revamping its rewards program and increasing its digital marketing efforts via the company's mobile app. The company expects these new efforts to contribute 1-2% to same-store sales in the Americas in fiscal 2019.

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China, on the other hand, is the center of Starbucks’ turnaround strategy. The company sees revenue tripling from that country over the next five years.

For long-term Starbucks investors, it’s a tough time to decide whether to remain faithful to the company and the stock while its problems are fixed, or to book profits after stock gained close to 600% during the past decade. It’s anybody’s guess when Starbucks’ turnaround plan will start to pay off, or whether it even will.

In our view, the company needs to drastically change its business model, as it stated in its strategic plan, turning itself into more of a lunch destination than just a place where one can consume caffeine and sugary drinks. Indeed, that’s the essential challenge for many global beverage companies, such as Coca Cola (NYSE:KO), as changing consumer preferences in the advanced economies become more health conscious.

Nevertheless, that doesn’t mean that Starbucks stock is no longer appealing. As the company matures and enters a period of slowing growth, this is the time when it becomes an attractive target for income investors whose objective is to earn steadily growing dividend income.

On this metric, we certainly like Starbucks. It has been returning more and more cash to investors after decades of explosive growth. One rarely finds a dividend stock yielding just below 3% that offers such impressive dividend growth. During the past three years, Starbucks delivered 24.4 % average dividend growth per share and with a payout ratio of just under 36%, that pace of cash-return doesn't look likely to slow anytime soon.

When it presented its long-term strategic plan in June, Starbucks also announced it would return $25 billion in cash to shareholders in the form of share buybacks and dividends through fiscal year 2020. That represented a $10 billion jump from the cash return target announced in November of last year.

Bottom Line

The Street's opinion on whether Starbucks will rebound is divided. The stock might prove to be a great turnaround bet if you agree with the company’s former CEO and outgoing chairman Howard Schultz. who sees Starbucks shares as “cheap and undervalued.” Our view is that Starbucks is turning into a classic “cash cow,” a stock you can milk for a hefty payout for years to come.

Written By: Investing.com