A behemoth hedge fund intends to take an active role in working with Starbucks to get the coffee powerhouse back on track; should investors take this as a cue to buy shares?
Starbucks (SBUX 24.50%), the iconic coffee juggernaut, has caught the attention of an elite hedge fund determined to revamp the faltering business.
The fund, Elliott Management, is an investment industry whale. It acquires stakes in public companies and drives operational improvements in their businesses, making it an “activist” investor. It does so by securing board seats, ousting executive teams, and sometimes taking companies private. Using this and other strategies, the fund has notched remarkable returns. From 1977 to 2022, its annualized return was 13.5%, nearly 2% higher than the S&P 500.
Elliott is now investing in Starbucks, seeing an opportunity to help return the company to its former glory. The coffee giant has been an awful investment over the last three years, with shares down 19% while the S&P 500 is up 22%.
So, should investors take Elliott’s involvement as a sign that the tide will turn for Starbucks and put money into the beaten-down shares?
Should investors ride Elliott’s wave and invest in Starbucks?
The short answer is no. Trying to piggyback off Elliott’s stock investments has historically been a bad idea. An analysis from 2018 to 2022 shows that the annual returns for investors using this strategy would have trailed the S&P 500 by 12%.
Although Elliott likely played a role in the appointment of new Starbucks CEO Brian Niccol, the company’s new plan is still unknown. So, let’s analyze where it currently stands.
Starbucks’ “Third Place” vision is fading, but prices keep rising
Starbucks became the world’s largest coffee company, backed by its visionary leader, Howard Schultz. After the feeling of camaraderie and comfort he experienced at coffee shops in Italy, his goal was to bring that to the rest of the world with Starbucks. The vision was to establish Starbucks as a “Third Place” where people could gather and spend time other than at home or at work.
Now, Starbucks is hardly a place where people spend time. In the United States, over 70% of the company’s orders now come through its mobile app and the drive-thru. It also now has stores where customers don’t even have the option to sit down.
Another issue for the company is its massive price increases. The average order price is up 50% from 2020 to fiscal Q2 2024. Although inflation in the general economy has been high, this increase is far larger. Over the same period, the Consumer Price Index (CPI) rose just 21%. Convincing customers to pay price increases over double that of the economy is a tough sell. This is especially true if going to Starbucks isn’t the “Third Place” experience it once was.
Prices can only go up so much before customers put their foot down
Starbucks’ deteriorating value proposition is manifesting itself in poor financial performance. After fiscal Q3, the company’s last twelve months’ revenue growth was the lowest in the last 13 quarters, at just 4%.
Things look even worse when observing comparable store sales. This figure strips out sales from new stores, as simply increasing the number of stores will increase revenue. Comparable store sales provide a more reliable view of revenue trends.
Growth in comparable store sales has turned negative. It seems customers may have finally hit a breaking point with Starbucks’ price increases and are ordering less because of it.
Global comparable store sales last quarter were down since the number of orders decreased, which was likely the result of the average order price increase. The case was even worse in the previous quarter. The numbers were especially bad in China, where the company has the most stores outside of the United States.
| Fiscal Q3 2024 Year-Over-Year Comparable Store Sales Growth (%) | |||
|---|---|---|---|
| Total Change | Change in Orders | Change in Average Order Price | |
| Global | (3%) | (5%) | 2% |
| China | (14%) | (7%) | (7%) |
Chart by Author. Source: Company filings.
Even with its increased prices, the company’s gross margin has fallen. It was 28.4% in Q3 2023 and now sits at 27.9%. The growth in the costs of labor and materials used to make drinks is outpacing the growth of the company’s revenues.
Investors should brew their portfolio with stronger ingredients as recession fears rise
The company’s forward price-to-earnings ratio of 24 is below its historical average of 28.5 over the past 10 years. However, with fears of recession rising, Starbucks’ comparable sales could keep falling.
Consumer sentiment has fallen each of the last four months, and the recent stock market declines are not likely to slow this down. Consumers will likely be increasingly wary of spending money on Starbucks’ high-priced products.
The appointment of Niccol is likely a step in the right direction. However, it won’t change the company overnight, nor can it change current economic headwinds. Investors should wait to hear Niccol’s vision for Starbucks before fully buying in.
The Motley Fool has positions in and recommends Starbucks. The Motley Fool has a disclosure policy. Leo Miller has no positions in any of the stocks mentioned.
