Starbucks (SBUX) released its Q2 2023 results on Tuesday after the close. While the coffee giant delivered revenue and earnings beats, its “disappointing outlook” sent investors scurrying for the exits. As a result, its shares fell by more than 9% in Wednesday trading.
The disappointing outlook in the opening paragraph concerns investor expectations leading up to the report. Analysts felt the company would easily beat Wall Street’s estimates for the quarter, thus raising its guidance for the rest of the year. So instead, Starbucks reiterated its existing outlook.
It seems strange that investors would react so negatively to the news. But, of course, the Federal Reserve raised the interest rate today by a quarter percentage point to 5.25%, its highest level in 17 years, so they might not be in much of a mood to digest any earnings results. The markets are down a negligible amount, with less than an hour left in the trading day.
This, to me, screams buying opportunity. But, of course, you could argue today’s decline is merely a case of investors selling on the news. I believe they’ll be back.
Here’s why.
China’s Coming Hard
The Starbucks earnings release mentions China six times. Here’s a quick breakdown of the main points:
A) China's same-store sales in the quarter increased by 3%, driven by a 4% comparable increase in transactions and a 1% decrease in the average ticket. Translation: The company’s biggest growth engine is starting to return to normal.
B) At the end of the second quarter, China had 6,243 stores, representing 17% of its global footprint. Translation: It’s got nearly 2,800 stores to build there by the end of 2025. That’s a lot of store revenue.
C) China generated $764 million in revenue in the second quarter ended April 2. Translation: That’s an average of $122,345 per store, about one-third of its 16,044 U.S. stores ($371,229).
The company’s Q2 2023 transcript mentions China 35 times. However, the comments of Chief Financial Officer Rachel Ruggeri really hit home.
“China posted comp growth of 3% in Q2, meaningfully exceeding our expectations, including 30% comp growth in March as we began lapping heightened mobility restrictions in the prior year,” Ruggeri said. “From the early weeks of January, when China emerged from peak infections and mobility restrictions were lifted in different cities, we saw a broad-based recovery across all trade zones, dayparts, and city tiers.”
The sky's the limit when it comes to China’s revenue potential.
However, as Ruggeri stated in the conference call, Starbucks didn’t raise its guidance because the recovery in China is still very fluid. While it expects its average weekly sales in China to increase, the uncertainty made it prudent to hold the line on its projections.
If that’s not telegraphing an overly conservative outlook, I don't know what is. But, on the other hand, I’d be shocked if it doesn’t deliver much higher results than it’s currently projecting for the second half.
What Are the Projections for the Second Half?
The company believes it will grow revenue and earnings in 2023 by 11% and 17.5% at the midpoint of its guidance. Further, it expects earnings per share to deliver sequential improvement in Q3 and Q4 2023.
“We are brewing on all cylinders across our building blocks of growth, namely strong comp, propelled by digital engagement, unrivaled innovation, and engaged partners, store growth anchored by best-in-class cash returns and margin uplifted by reinvention as it continues to gain traction,” Ruggeri stated in her closing remarks of the conference call.
I’m not sure why analysts think Starbucks should go out on a limb regarding the second half when almost every CEO in the S&P 500 has been relatively conservative in their projections. They [CEOs] generally believe there will be a recession at some point in the second half of 2023 or the first half of 2024. Yet Starbucks is supposed to buck that trend.
Better to underpromise and overdeliver than vice versa. If I’m an existing shareholder, I would appreciate the honesty.
Starbucks will do just fine in the third and fourth quarters. So I guess we’ll see.
The Bottom Line
Through the first half of fiscal 2023, Starbucks generated $2.36 billion in cash flow from its operating activities, 16% higher than in the first half of 2022. In terms of free cash flow, it had $1.36 billion through the first six months, 17.1% higher than in the same period a year ago. This is despite spending an additional $130 million on property, plant, and equipment than it did last year.
The company’s trailing 12-month free cash flow is $2.75 billion. While it’s not equal to the $4.5 billion generated in fiscal 2021, it could get there sometime in 2024 if we only get a mild global recession.
SBUX stock is fairly valued or even a little undervalued by almost every financial metric relative to the past five years. Today’s correction certainly helps in that regard.
The Starbucks data point that always catches my eye is its U.S. Starbucks Rewards membership numbers. In Q2 2023, they were 30.8 million, 15% higher than Q2 2022. As long as this number’s moving higher, the business is probably doing just fine.
The company’s “disappointing outlook” is, in my opinion, a big reason to buy. Unfortunately, investors overreacted on this one.
On the date of publication, Will Ashworth did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
