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SBUX may be setting the model for coping with coronavirus; does that make it a buy?

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I often observe, and write about the need to try to filter through the “noise” of the market to find the right ways and places to put your money to work for you. A lot of that noise, of course comes from media outlets, including market news. The irony of my observation is that it is equally necessary to stay abreast of current issues and conditions that are impacting the world, not only economically but also in real, societal terms. That means that you do have to pay attention to the very sources that are throwing so much information at you that just isn’t useful or practical to help you make informed, objective decisions.

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Sometimes, though, the media does a great job of providing good information. This morning as I watched CNBC for my daily dose of the morning’s market activity, Kevin Johnson, CEO of Starbucks Corp (SBUX) joined the broadcast from his home office (by the way, I think that is going to be a long-term part of our new “normal” – American workers at every tier of an organization working from home at whatever point it is reasonable and practical to so do). SBUX occupies an interesting niche in the retail world – they are categorized in the Consumer Discretionary sector, which is naturally pretty sensitive to consumer-level economic forces, but even more so in its industry, which is Hotels, Restaurants & Leisure. That usually means that when the economy struggles, this is an industry that also struggles.

COVID-19 and broad-based shutdowns across the globe have, not surprisingly wreaked havoc with companies in this industry. Hotels, travel companies, and airlines all seem radioactive right now and will likely remain so, at least until the public begins to get a sense that the worst is behind us and it’s safe to begin resuming normal activities. At the same time, it is very interesting to see some of the strategies being employed in the corporate world to “batten down the hatches” and prepare to ride out the storm are coming from lessons learned by retail companies like SBUX from their experience dealing with the outbreak in China.

Mr. Johnson talked quite a bit, not only about the things they learned about how to get through a tough, extended period of time, but also about the fact that many SBUX stores in China are now reopening and slowly starting to get back to business. Over the years, I’ve observed that Mr. Johnson is also a pretty progressive thinker, and that showed through as he talked about what his company is doing to get through the next stage of the outbreak here in the U.S. He has committed to pay all employees and partners full compensation for next 30 days, regardless of whether a store is open or those workers feel like working. That’s a pretty stark contrast from measures other companies in the industry are taking, where they are being forced to lay off by the hundreds, or sometimes even thousands, scale back hours, and hope that federal unemployment insurance can help those individuals get through.

Mr. Johnson talked about the strength of his company’s balance sheet in being able to make that kind of commitment, and it certainly is laudable, and something that, as a consumer and market observer, makes me want to see this company do well. The practical, analytical side, however is what ultimately guides my investment decisions, so I have to subordinate my emotional response to that progressive approach to what my fundamental and value-based analysis dictates. Let’s run the numbers so you can decide for yourself.

Fundamental and Value Profile

Starbucks Corporation (Starbucks) is a roaster, marketer and retailer of coffee. As of October 2, 2016, the Company operated in 75 countries. The Company operates through four segments: Americas, which is inclusive of the United States, Canada, and Latin America; China/Asia Pacific (CAP); Europe, Middle East, and Africa (EMEA), and Channel Development. The Company’s Americas, CAP, and EMEA segments include both company-operated and licensed stores. Its Channel Development segment includes roasted whole bean and ground coffees, Tazo teas, Starbucks- and Tazo-branded single-serve products, a range of ready-to-drink beverages, such as Frappuccino, Starbucks Doubleshot and Starbucks Refreshers beverages and other branded products sold across the world through channels, such as grocery stores, warehouse clubs, specialty retailers, convenience stores and the United States foodservice accounts. SBUX has a current market cap of about $75.4 billion.

Earnings and Sales Growth: Over the last twelve months, earnings increased by 5.3%, while revenues improved by 7%. In the last quarter, earnings improved nearly 13%, with revenues up a little over 5%. SBUX is a company that operates with a healthy margin profile; in the last twelve months, Net Income was 13.8% of Revenues, and only dropped a bit to 12.4% in the last quarter. Looking ahead, it is probably reasonable to forecast these numbers to decline further, but for now their operating profile is a useful sign of strength.

Free Cash Flow: SBUX’s free cash flow $2.73 billion over the last year. This number has declined from a peak at around $10.5 billion in July of 2019, which is a concern, and translates to a current Free Cash Flow yield of 4.1%.

Dividend: SBUX’s annual divided is $1.64 per share and translates to a yield of 2.9% at the stock’s current price.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $23 per share, which means that SBUX is significantly overvalued, by more than -64% below its current price. Emotions aside, that means that, like most stocks in its industry, SBUX remains a very risky investment at current prices and under current conditions. It hasn’t seen levels in the $22 price range since late 2013.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s longer-term downward trend; it also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock’s peak came in late July of 2019 just a little below $100. It has declined steadily from that point, with most of the decline coming in the last month as the market finally turned bearish. The stock is showing good support right now around $55, with resistance at around $69, in-line with the 38.2% Fibonacci retracement line.

Near-term Keys: SBUX’s deteriorating fundamentals are a strong reason to believe the $22 price target for SBUX is practical. I’m not saying the stock is going to drop that far, but the truth is that it very well could. There is very little in the way of fundamental argument to suggest that the stock should be priced even where it is, so as a long-term investment I think the smart move with SBUX is to stay away and come back in a few months to take another look. If you prefer to work with short-term trades, and the stock’s near-term momentum remains bullish (which is possible, especially if the government comes through with a much-anticipated stimulus bill this week), you could make an aggressive bullish play by buying the stock or working with call options, with an eye on $69 as a quick-hit price target, or possibly even $75 (where the 50% retracement line sits) possible if sentiment remains positive. If, however, broader concerns remain in force, and movement from Congress continues to be delayed, don’t be surprised to see the stock drop below support at $55. If that happens, you might consider shorting the stock or working with put options, with an eye on $48 – where the stock bottomed around that level in June 2018 before rallying for the next year – as a profit target.

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