Buy Starbucks stock. Shares could be ready to go.

China’s economic slowdown is among the factors putting pressure on Starbucks shares. Above, delivering coffee to on-the-go customers in Hangzhou.

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A sequel is rarely as good as the original, and the less said about sequel sequels, the better. Howard Schultz, the former CEO recently returned to the helm

Starbucks
,

may be the exception, giving investors a reason to buy downed stocks.

Shares of the Seattle-based company fell 36% in 2022, marking its worst year since 2008. Starbucks (ticker: SBUX) has been hit by the possibility of slowing the growth of its rewards program and its efforts to unionization in its stores, as well as the economic slowdown in China and soaring inflation in the United States, which increased costs. The possibility of a recession only adds to the list of investors’ worries about the company’s prospects.

Enter Schultz, who returns to Starbucks only four years after his departure. Schultz bought the company in 1987 and created what we call the modern Starbucks, charting its rise from a corner cafe to an international chain with a cafe seemingly on almost every corner. From 1992, the company’s first year as a public company, to 2000, the end of its first helm, the stock returned 37.7% annually, compared to the


S&P500

the index is 19.7%.

Schultz returned as CEO in January 2008, and the stock had an 18.2% annualized return until his departure in June 2018, outpacing the S&P 500 return of 8.9%. Now Schultz is back – he announced his return in April – and ready to tackle Starbucks’ problems head-on.

The last time Schultz returned, he cut costs to see the company through the 2007-09 recession. Starbucks could use its budgeting skills again. For its 2022 fiscal year, which ends in September, the company is expected to see its costs of sales, which include wages and raw materials like coffee beans, increase by 30%. In May, the company said it would see an additional $200 million in spending from investments in salaries, employee training and technology over the next few months, which analysts say will add up to more than $500 million. dollars of additional annual costs in 2023.

Still, it’s not 2008. Costs aren’t going to come down, but the worst of the increases should be over. And Schultz, for his part, knows he must be willing to invest for growth, even if that means looking past some short-term pain.

Schultz should get help along the way. The good news starts in China, which has been a hotspot for Starbucks. As same-store sales in the world’s second-largest economy fell 23% year-over-year in the second quarter, China lifted some of its Covid-related restrictions in May. Starbucks’ sales in the country – which made up $4 billion, or 12% of its total sales, over the past 12 months – are expected to start to improve and could even return to pre-Covid levels by first half of 2023.

“China was a mess, and all of a sudden you have a story of China reopening,” says Stephanie Link, chief investment strategist at Hightower Advisors, which owns the shares.

Starbucks should also continue to see a recovery in the United States. Store traffic remains around 10% below pre-pandemic levels, Evercore ISI estimates, and continued improvement is expected to help US sales, bringing overall revenue to around $32.3 billion in 2022. Starbucks also highlighted its “consistent pricing power” on its second-quarter conference call in May, which helped boost its profits in North America. In total, analysts expect Starbucks sales to grow another 10%, to $35.6 billion, in 2023.

But sales growth won’t help much if Starbucks can’t turn more of its revenue into profit. Analysts expect the operating margin to rise from 14.8% in 2022 to 15.8% in 2023. This would bring it back to 2021 levels, when margins were around 18%, as costs should start to slow, even as the company continues to dedicate to growth. “Capital spending will be relatively modest compared to the impact of inflation on US margins this year,” writes the Evercore analyst. david palm.

Earnings per share are expected to fall to $2.89, down 11% from $3.24 in 2021, but are expected to rise 20% in 2023, to $3.47. And if fixed costs remain mostly under control, EPS could rise 15% annually to $4.38 by 2025.

If Starbucks can hit those numbers, the stock could be, if not a bargain, at least pretty compelling at current valuations. It is trading at just over 22x 12-month forward earnings, near its lowest level since 2020 and below its five-year average of 27.3x. Closing that gap to 25 times 2024 earnings would put the stock at $98, up 30% from Thursday’s close of $75.20. “It’s pretty cheap compared to where it historically traded,” says Credit Suisse analyst Lauren Silbermanwhich calls 25 a “fair” valuation and has an outperform rating and $103 price target on the stock.

The materialization of these gains depends on Schultz. It needs to make immediate investments, like spending to train baristas for new store layouts, while continuing to grow the Starbucks Rewards program, whose members spend two to three times more than nonmembers each year. Silberman, for his part, says membership could grow to more than 70 million in the next few years, up from just under 30 million currently. Schultz will have the opportunity to present all of this during Starbucks Investor Day on September 13, when the company is expected to provide updated long-term guidance.

This could really give the stock a jolt.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

About Barbara J. Ross

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