Shares of popular coffee chain Starbucks (SBUX -0.26%) spent much of the past year on a steady decline after investors were unimpressed with the company's new leadership following the retirement of founder Howard Schultz. But things can change quickly on Wall Street. A couple of high-profile activist investors got involved with Starbucks, which then jettisoned its chief executive officer and replaced him with Brian Niccol, who was leading Chipotle Mexican Grill.
The move has won back investors. The share price has surged roughly 30% over the past month. With that gain in the rear-view mirror, is it too late to get back into Starbucks stock?
New leadership brings excitement to Starbucks
Former CEO Laxman Narasimhan had a tough task following Schultz, who built Starbucks from a regional chain into a global machine with over 39,000 stores. Sales momentum had steadily waned as consumers pushed back on constant price increases and longer wait times on orders. Schultz himself criticized Starbucks, describing the brand as losing its shine. In addition, competition has aggressively challenged Starbucks in China, where it is pursuing strategic expansion.
New CEO Niccol had led Chipotle since 2018. During his tenure, sales more than doubled, and the stock appreciated by more than 800%.
Investors hope Niccol's leadership will bring the spark back to the Starbucks brand. The chain has plenty of competition, and it's generally among consumers' more expensive coffee options. Schultz's retirement showed investors that despite its global dominance, Starbucks still needs sharp leadership to perform well.
A new CEO has a lot to work with
There is no denying that its sales have struggled in recent quarters, but Starbucks is still a great business because it has fantastic underlying fundamentals.
Casual consumers have cut back, but it's still building a large and growing base of hardcore customers. In its fiscal third quarter, the company's rewards program grew to 33.8 million active members in the U.S., up 7% year over year and 3% from the prior quarter. These people are more likely to load funds onto their Starbucks payment cards, creating deferred revenue that essentially equates to an interest-free loan to the company. Starbucks had $1.8 billion in deferred revenue stored on payment cards at the end of June.
The business itself is profitable. Starbucks converts more than 10% of its sales into free cash flow -- profits left after investing in new stores that it can use to pay dividends or repurchase shares. Starbucks has paid and raised its dividend for 14 consecutive years while decreasing its outstanding share count by more than 24% during the past decade.
Starbucks has expanded its store count, increased same-store sales, and reported rising profit, driving the stock's long-term market-beating performance. Starbucks has outperformed the S&P 500 over its lifetime, and during most of the past decade until the stock's decline after Schultz left the company.
Is it too late to buy the stock?
Niccol's success at Chipotle doesn't guarantee Starbucks will thrive under his watch, too. However, the company has an iconic brand and strong financials, so some better management could be what it needs to return to excellence.
Fortunately for investors, even after its recent gains, the stock is still reasonably priced in a way that reflects this uncertainty. In other words, the stock has a margin of safety.
Shares now trade at a discount to their average enterprise-value-to-sales ratio during the past decade.
SBUX EV to Revenues data by YCharts.
Analysts expect Starbucks to show little to no sales growth this year, but to return to high-single-digit percentage growth next year and beyond. Throw in some share repurchases and pricing power, and analysts are looking for about 11% annualized earnings growth over the next three to five years. Its forward P/E ratio of 27 is a solid valuation for an iconic brand like Starbucks.
The stock isn't a table-pounding bargain like it was a month ago, but long-term investors can still buy shares cheaply enough to enjoy strong returns if Starbucks returns to form.
