2023-08-09 10:30:00 ET
Summary
- Starbucks Corporation recently reported earnings on August 1, beating analysts' estimates in EPS and missing slightly on revenue.
- With its Starbucks Rewards members continuing to grow at 31.4 million members, SBUX operates very similar to a bank and holds more money than some of the most popular ones.
- SBUX is a hold forever stock, and investors looking to start a position should wait for a potential pullback in price for a nice margin of safety.
- Starbucks brought in a record $9.2 billion in revenue in fiscal Q3 and continues to focus on growing its footprint in China and other international segments now that the pandemic is considered a tailwind.
Introduction
Starbucks Corporation ( SBUX ) recently reported its fiscal Q3 earnings last week, and the iconic brand reported some very strong growth. Listening to the earnings call , one thing that has continued to impress me is their rapid growth in Starbucks Rewards members. Although inflation was at a record high last summer, the Fed raised interest rates at its fastest pace in history, and there was still a lot of uncertainty in the U.S. banking system, the coffee giant has continued to grow its rewards members. I have plenty of co-workers who are rewards members, and they spend their money faithfully on Starbucks coffee.
Over the last decade, it seems like coffee has become a daily ritual and I can tell you military personnel can't seem to survive without it. I've never been a huge coffee drinker, but I do drink a black cup of coffee occasionally for the health benefits. Now people drink it because it seems part of the American way of life. It's talked about all over social media, and you can't go anywhere without anyone having a cup in their hand. And Starbucks has continued to benefit and take advantage of this as seen by their long drive-thru lines.
Birth Of The Starbucks Rewards Program
The Starbucks Rewards Program made its debut in Spring 2008, with a Gold Loyalty Program later in the year. The next year, the programs merged to create the rewards program that it is today. Like all great businesses, the coffee retailer took advantage of the economic downturn, the Great Financial Crisis. The program debuted 2 years later in 2011. Back then, the company would give you your 10th drink for free. Just think about that. The company gets you to spend your money nine times before finally giving you something. By that time, you've already spent close to $50. People like to be rewarded or to get something for free. I mean, who doesn't?
For those living under a rock, the rewards program is where members load money onto their rewards card, and every time they spend money, they get a certain amount of stars towards their next drink. Depending on how you pay, members can earn from 1 to 3 stars per visit, and if you pay with your Starbucks Rewards Visa card, you earn the most stars, 3. And like a true credit card, new members earn so many bonus points when they spend a certain amount of money in a certain time frame, normally in a quarter period. If members decide to pay any other way, they have to scan their rewards card to earn the points.
I think this is a genius move by SBUX because most people like things that are convenient. And to make sure they don't miss out on their rewards, many members would rather apply for the credit card to make sure of this.
The Undercover Bank
As seen in the chart below, this was the cash SBUX held in 2016 compared to companies such as American Express ( AXP ) and PayPal ( PYPL ). When customers put their money in a bank like Bank of America ( BAC ) or JPMorgan Chase ( JPM ), they're essentially loaning the bank money, then the bank turns around and invests that money into stocks, or loans their money to other customers and charges them an interest rate while they pay you pennies on the dollar. With SBUX, when members load money onto their rewards cards, they're unknowingly providing the coffee company with an interest-free loan to do whatever they want with it. That can be used to expand the business or invest in the market. But unlike a legal bank, SBUX can't withdraw the cash. So that's where they differ.
Banks also have to keep a certain amount of money, so customers can withdraw their money whenever they need to. We all witnessed this with the bank failures back in March. SBUX does not have to do this as members are not coming to withdraw their cash. They're looking to use their cash to purchase Starbucks and Starbucks only. So that's where the company has an advantage. Additionally, for several years, the company has reported that there are millions of dollars forgotten or never used every single year.
Exponential Growth
Last month, I wrote an article on SBUX expounding on the potential growth in India. I was happy that Wall Street Breakfast highlighted my article as well. Readers can check it out using the link. And while I do believe we see SBUX expanding its footprint into the world's most populous country in the future, India, the company is primarily focused on continuing its growth in North America and China. Sales in the U.S. increased 7% while international sales increased by double digits to 24%. China's comparable store sales increased by almost 50%. The company also brought in record revenue for the quarter at $9.2 billion, up from $8.7 billion in Q2. The coffee retailer also opened up 588 new stores to bring their total to 37,222 stores globally.
Now let's talk about the thing that impressed me the most, the growth in rewards members. Last quarter, SBUX had 30.8 million active members. During their recent earnings , that number reached 31.4 million in the U.S. alone and 75 million worldwide, a growth of 25%. A big part of this growth is - you guessed it! - China, who had a record 20 million Rewards members, which debuted in the country 8 years later than the U.S. in 2016.
Turning Tea Drinkers Into Coffee Drinkers
In my last SBUX article, I mentioned how I thought the iconic coffee retailer would eventually break into India. There was some pushback from a few commenters saying that SBUX is not worried about India because they were a tea-drinking culture and that there were very few Starbucks stores in the country. Before the iconic brand arrived in what once was the most populous country, China, they too were a tea-drinking culture, and now the country has nearly 6,500 SBUX stores. Per capita people in China consume more tea than people in India at 1.25 compared to 0.90. The company still considers itself to be in its early stages of potential growth in China. The country is second now behind India in population, and I agree that there's a lot more growth in the future going forward. In comparison, the U.S. had 16,144 stores while China had 6,480.
As you can see, the U.S. has almost triple the amount of stores China has. And then there's the growth potential in countries like Japan and Canada as well. Their CEO commented that he expects 10 to 12% revenue growth and 15 to 20% EPS growth by the end of the year and with the continued growth of rewards members & store openings I see Starbucks accomplishing this easily. The company also reported double-digit growth in its Japan and U.K. stores.
Valuation
I think Starbucks looks reasonably valued here, with its dividend yield in-line with its 5-year average. Investors looking to start a position should wait for a potential pullback in price before jumping in for a margin of safety. Analysts have a price target of $117, so investors do get some upside at the current price. Some are even calling for a potential correction this month. SBUX last saw a nice price dip back in September 2022, and if a correction does indeed occur, there may be a better entry price coming soon. I believe SBUX is a buy under $100, preferably in the $80-$90 range. I have an intrinsic value price of $148, similar to analysts' high target price of $150.
I do believe SBUX is at an acceptable buy price due to the potential upside from here, but I would wait for a pullback due to a correction or tax-loss harvesting from investors looking to offset their capital gains, possibly later this year.
Risks To Consider
With a looming recession and more people drinking coffee from home, I'm assuming a large part of this is due to the new hybrid work schedule many businesses have adopted since COVID. SBUX expects to see continued pressure going into Q4.
Then there's the threat of continued unionization in its stores, but this seems to be improving. The company has been making various improvements such as increasing store hours per partner, which has seen improvement in productivity and partner engagement. With inflation still above the FED's target of 2% and interest rates expected to remain higher, one way to help its employees is then new My Starbucks Savings , a new way to help eligible partners save for the unexpected. Partners are able to contribute a portion of their pay to a personalized savings account, and SBUX will contribute $25 and $50 credits at key saving milestones up to $250.
Investor Takeaway
Starbucks is one of the most iconic brands on the planet and continues to find innovative ways to continue growing the company. I believe they are a forever hold and a great addition to any dividend portfolio due to rapid dividend growth over the last 5 and 10 years. Their current dividend of $0.53 is very secure with reported EPS of $1.00 in Q3 and its cash flow of over $1 billion for quarter three. I believe their Rewards Program will continue to be a major driver for sustainable growth, creating value for long-term shareholders.
For further details see:
Starbucks Fiscal Q3: Laughing All The Way To Its Bank