The company might need some outside perspective to get back on course.
During the final week of July 2021, shares of coffee giant Starbucks (SBUX -2.07%) hit all-time highs above $126 per share. It’s down about 40% from this all-time high almost exactly three years later because investors are concerned about some real problems with the business.
It’s important to not overstate the gravity of the situation for Starbucks. At the end of the day, the company has 39,000 locations worldwide, has generated over $36 billion in trailing-12-month revenue, and earned more than $4 billion in net income in the last year. Most companies would love to have this “problem” business.
Starbucks is a hugely successful business but is not living up to its full potential right now — which is what’s bothering investors. In the fiscal second quarter of 2024 (which ended in March), sales transactions slipped 6% year over year. And things were slightly worse in key North American markets, with comparable transactions falling 7%.
Starbucks stock is now trading near five-year lows and is drawing some activist-investor attention. According to The Wall Street Journal, Elliott Investment Management now has a “sizable” stake in the business and is talking to management. And that might just be what this coffee company needs right now.
Is this a wake-up call for Starbucks?
Starbucks named Laxman Narasimhan as its CEO just over a year ago after founder and CEO Howard Schultz retired. Therefore, the recent business slowdown has happened under Narasimhan’s watch.
Starbucks’ current management believes it partly has a pricing problem. In the Q2 earnings call, Narasimhan said the company needs to, “Reach and demonstrate more value for our occasional and non-Starbucks Rewards customers.”
This doesn’t sound like the real issue to me. Generally, I’d be inclined to elevate the opinions of management over my own since it has a better front-row seat to the business. But my dissenting opinion has good company in this case — Schultz himself has a view that differs from management’s regarding what’s going on with Starbucks.
After Q2 earnings from Starbucks, Schultz wrote on social media: “It’s not the miss that matters. It’s what comes next.” In short, he appears to disagree with Narasimhan and believes the more appropriate response is to focus on the company’s culture and customer experience, not prices. In the end, he said the moves should reinforce “the company’s premium position,” which is the opposite of demonstrating more value.
Elliott Capital Management reportedly took a stake in Starbucks to push for changes — that’s what activist investors do. There’s a chance management will just listen to the suggestions in private. It’s also possible that Elliott could get seats on the board of directors. But either way, I believe this will be a caffeinated wake-up call for Starbucks.
A management team can have a plan, but when the former longtime (and successful) CEO suggests you’re on the wrong path, that means something. And when your stock has dropped enough to attract attention from activist investors, it’s time to identify problems and propose better solutions.
What should investors do now?
Starbucks investors should consider two things: Earnings are down and the valuation is relatively cheap. Regarding valuation, Starbucks stock trades at about 21 times its trailing earnings, which is well below its 10-year average.
SBUX PE Ratio data by YCharts.
When earnings slip, valuations increase, assuming everything else is equal. Therefore, Starbucks’ cheaper-than-usual valuation is particularly noteworthy because its earnings are also down. If the company gets its earnings back on track by making the right course corrections, the valuation would look even more attractive.
I’ve been looking at this situation with Starbucks stock for a while now. But I haven’t bought the dip because I didn’t agree with management’s assessment of the situation or its approach to fixing things. I thought the company would have to wander for a little while before eventually being compelled to take a deeper, introspective look at things. But I would imagine that the stake from Elliott speeds up the timeline.
The faster Starbucks correctly identifies and fixes the issues with its business, the sooner its earnings can rebound. And once its earnings rebound, I expect the stock to respond positively, especially given its cheaper-than-usual starting point.
As a closing caveat, this entire discussion assumes that Schultz and Elliott Investment Management see things more clearly than Starbucks’ management does — and they may not. Moreover, even if they’re correct, they need management to be receptive to their input.
Therefore, investors shouldn’t count their coffees before their cups are filled. But in my view, Elliott’s involvement could ultimately be a positive development for Starbucks stock.