Starbucks Earnings Look Strong, But There’s Little Upside For Shares

Starbucks Weekly Chart

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– Reports Thursday, Jan. 24, after the market close
– Revenue Expectation: $6.49 billion
– EPS Expectation: $0.65

Overall, it would look like there’s little to worry about for Starbucks (NASDAQ:) ahead of its fiscal first-quarter earnings report next week. Analysts are generally upbeat about this coffee chain after it beat expectations , breaking out of its home-market slump. Comparable sales, the key gauge of any retailer’s performance, are coming back in the U.S.

The maker of popular Frappuccinos and pumpkin-spiced lattes is also expanding globally, especially in China, which is at the center of its global growth strategy.

Starbucks Weekly Chart

But one caveat that we see in this generally upbeat outlook is that most of the good news is already baked in the stock price. Shares rallied to a record $68.98 after the past quarterly beat and there isn’t much left in the short run to push them higher, unless Q1 numbers show a drastic turnaround.

The chances of a big positive surprise are slim. Starbucks, like many food and drink sellers, is fighting a cyclical downturn where consumers are turning away from unhealthy drinks.

Few Places To Grow

Emerging stronger from this industry-wide slowdown isn’t easy. Starbucks’ home market is saturated and it faces competition from smaller players that are in a much better position to offer coffee and donuts at much lower costs.

That’s the reason Starbucks’ U.S. comparable sales growth since 2015 has averaged less than half what it had been in the previous three years. The only big growth driver that’s left untapped is China, where the company is trying hard to win more customers.

The fourth quarter showed that that market still has potential. Comparable sales in China turned positive sooner than many analysts had anticipated. These results might continue to improve as Starbucks expands its delivery partnership with Alibaba (NYSE:).

But deteriorating U.S.-China ties as a result of an escalating trade war pose a great risk to all those companies that have made the Chinese market a key part of their growth strategy. Apple (NASDAQ:) recently , mainly blaming waning Chinese demand.

We don’t want to downplay the partial success of the company’s turnaround strategy. The first-quarter earnings will mark two full quarters under Chief Executive Kevin Johnson after the retirement of longtime leader Howard Schultz, who stepped down as chairman in June.

Under data-driven Johnson, Starbucks is trying to offer customers what they want by better understanding their ordering behavior. Its recently-launched mobile order app attracted 4 million new digitally-registered customers in the past quarter. The number of guests in its loyalty program is also growing, with 15.3 million active members in the U.S., up 15 percent from a year ago.

That said, we are also of the view that Starbucks will find it almost impossible to return to a growth trajectory when it managed to raise earnings at a 20 percent-plus rate for many years. Instead, we see the company entering a period of slowing growth, where it will continue to return more cash to investors.

Investors rarely find a dividend stock yielding more than 2 percent that offers such impressive dividend growth. During the past three years, Starbucks delivered about 25 percent average dividend growth per share. With a median payout ratio of about 42 percent over the last four years, that pace of cash return doesn’t look likely to slow anytime soon. However, some reassurance about this year’s dividend in next week’s guidance could surely help.

Bottom Line

Starbucks is a good cash-generating stock and income-seeking investors should take advantage of any weakness in its share price next week post earnings. Starbucks shares trade at a very reasonable valuation and with the company’s aggressive share-repurchase plan and robust growth in its payout, it offers a good risk-reward equation for buy-and-hold investors.

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