Investor Essentials Daily

Inflation is brewing trouble for this coffee giant

May 15, 2024

Coffee is often viewed as an essential product, making companies like Starbucks (SBUX) seemingly resilient to economic downturns due to its addictive nature and daily utility for consumers. 

Despite this, Starbucks recently cut its full-year guidance during its Q2 earnings call, leading to a 16% drop in its stock price in one day. 

The company has faced increasing input costs and declining same-store sales in North America and internationally, resulting in lower profits. 

The cut in guidance indicates the potential erosion of Starbucks’ competitive edge amidst strong macroeconomic pressures and increasing competition from new market entrants. 

Additionally, high valuation multiples persist despite these challenges, suggesting the market’s ongoing high expectations which may be hard to meet given the current economic and competitive landscape.

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Coffee products are often seen as consumer staples that people will continue purchasing regardless of economic conditions.

As an addictive substance, coffee provides both utility and enjoyment to customers on a daily basis. Therefore, the argument could be made that Starbucks (SBUX) is well-positioned to withstand inflation and economic downturns.

However, Starbucks’ recent decision to cut its full-year guidance paints a different picture. 

In its Q2 earnings call, the world’s largest coffeehouse chain slashed its projections, causing its stock price to plummet 16% in a single day.

Investors had come to view Starbucks as a high-growth company over the years; failing to meet elevated expectations for expansion resulted in a severe punishment from the market.

Management revealed on the earnings call that short-term challenges have squeezed margins over the last quarter.

Rising input costs including labor, raw materials, and utilities, are pinching profits. Same-store sales in the quarter fell 3% in North America and 6% in international markets, pushing revenue down 1.8%. Furthermore, the operating margin also fell 140bps year over year.

These trends suggest Starbucks is struggling to pass rising expenses onto customers without dampening demand.

The guidance cut also implies the company’s competitive advantages may be eroding. As the pioneer of the coffee shop experience, Starbucks has long captivated customers with its brand image and consistent quality. 

However, macroeconomic headwinds like inflation could be weakening customer loyalty. New entrants are also gaining share with innovative ordering and drive-thru-focused formats.

Additionally, our EEA shows Starbucks’ valuation multiples provides further reason for concern.

Even after the post-earnings tumble, shares still trade at a lofty 30x Uniform P/E and 7x Uniform P/B ratio based on reduced earnings targets. 

The market is betting heavily on a return to outsized growth, but macro and competitive pressures may foil such expectations for the foreseeable future.

Former CEO Howard Schultz’s recent warnings about problems plaguing U.S. stores also highlight the challenges ahead.

Major operational fixes are needed to optimize processes and revitalize the customer experience as inflation squeezes wallets. But implementing meaningful changes will require significant time and capital during an uncertain economic period.

Best regards,

Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research

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