Investment Thesis: I take the view that Starbucks Corporation has the potential for upside on the basis of growth in revenues and transaction volume, and an attractive EV/EBITDA ratio.

In a previous article back in September, I made the argument that Starbucks Corporation (NASDAQ:SBUX) has the capacity to further increase transaction volumes going forward, but the company needs to show a meaningful reduction in long-term debt to justify further upside.

Since then, the stock has ascended to a price of $97.44 at the time of writing:

The purpose of this article is to assess whether Starbucks Corporation has the ability to see continued growth from here taking recent performance into consideration.

Performance

When looking at Q4 2023 earnings results for Starbucks Corporation (as released on November 2 2023), we can see that total net revenues showed double-digit growth as compared to the prior year quarter, and net earnings per common share also showed growth of nearly 40% over the same period.

I had previously made the argument that Starbucks had been demonstrating encouraging growth in transactions as compared to quarters pre-pandemic. When looking at the North American market, we can see that transactions have grown by 2% in Q4 2023 as compared to the prior year quarter.

In particular, I would like to analyse ticket growth versus transaction growth in more detail for both the North America and International markets.

When looking at a breakdown of change in ticket vs. change in transactions by quarter, we can see in the below bubble chart that the North American market has seen a greater percentage growth in ticket (as seen on the y-axis of the chart) over the past eight quarters as compared to the International segment.

That said, when looking at change in transactions (as indicated by bubble size) – we can see that the International segment has seen substantial growth in the latter three quarters of this year. An interactive version of this plot is available here.

Even though North America accounts for a much larger portion of overall revenue as compared to that of the International segment – the fact that we have been seeing an uptick in both ticket and transactions across the latter is encouraging.

I had also made the argument that while the growth in revenues and earnings for Starbucks had been encouraging – the company will ultimately need to see a reduction in long-term debt to justify further upside.

That said, when we look at the long-term debt to operating income ratio of Starbucks, we can see that the same has decreased over a four-year period – with growth in operating income outweighing growth in long-term debt as a whole. The ratio below was calculated as (short-term debt + long-term debt – cash and cash equivalents)/(operating income + depreciation and amortization expenses).

Oct 2019 Oct 2023 Operating income 1195.5 1706.2 Depreciation and amortization expenses 357.4 351.4 Short-term debt 175 33.5 Long-term debt 13119.9 13547.6 Cash and cash equivalents 2818.4 3551.5 Long-term debt to operating income ratio 6.75 4.87 Click to enlarge

Source: Figures (in millions USD except ratios) sourced from Starbucks Q4 and Full Year Fiscal 2023 Results. Long-term debt to operating income ratio calculated by author.

From this standpoint, it is particularly encouraging that Starbucks has not had to increase long-term debt to fund growth in revenues and operating income, and a continuation of this trend will be encouraging.

Risks

In terms of the potential risks to Starbucks Corporation at this time, a recent slowdown in sales has investors concerned – with the stock itself showing a consecutive 11-day drop in price as well as a downward trajectory since mid-November also marking the longest losing streak for Starbucks in its history.

Particularly, the main concern among investors at this point is that Starbucks may see disappointing sales performance during the holiday season – which would be reflected in Q1 2024 results coming in below expectations.

In this regard, while we have seen growth in revenue and transaction volume – a slowdown in performance could place downward pressure on the stock going forward.

My Perspective and Looking Forward

As regards my take on the above results and the implications for the growth trajectory of the stock going forward, I am impressed at the fact that Starbucks has seen an uptick in transaction volume. We saw that North America saw growth of 1% from that of the prior year quarter, while the International segment saw a substantial climb of 6% over the same period.

In this regard, the fact that Starbucks is not simply relying on increases in ticket (or increases in average spend per customer) to bolster revenue and transaction volume itself is increasing is an indication that demand remains buoyant. One of the risks in an inflationary environment is that revenue growth may simply be driven by price increases – which is not sustainable long-term without volume growth as well.

When looking at the EV to EBITDA ratio for Starbucks over a five-year period, we can see that the same is trading near a five-year low while EBITDA per share is trading at a five-year high.

In this context, I take the view that the stock could potentially be undervalued at this point in time. When looking at a longer-term trajectory for price, we can see that Starbucks was trading near the $130 level in 2021 despite a lower EBITDA at the time.

In this regard, I take the view that the stock has the potential to rebound to the $130 mark if we continue to see encouraging growth in earnings.

In terms of the potential growth drivers that I see for Starbucks going forward – particularly in light of the recent decline in the stock amid sales concerns – we have seen that transaction growth has rebounded particularly strongly across the International segment. Moreover, relative to the prior year quarter, store count has also increased significantly across the International segment by 9.8% as compared to 2.9% for North America.

From this standpoint, I take the view that should we see a continuation of this trend – then Starbucks has the capacity to bolster overall revenue and counteract the downward pressure we are seeing on the stock at this point in time. Specifically, slowing credit card data has triggered fears among investors that the holiday season will show a lower degree of sales than expected for this time of year. While this is a possibility due to inflation and macroeconomic concerns, my view is that the market is potentially being short-sighted on the performance of Starbucks and I take the view that the company has the capacity to increase long-term revenues going forward.

Performance has already been strong with the company reporting record fourth-quarter revenue of $9.4 billion thanks to strong sales in both North America and internationally. Moreover, with Starbucks expected to grow number of stores to 55,000 worldwide by 2030 (an average of eight stores per day), I take the view that the company is in a strong position to fund this given the decrease in long-term debt to operating income that we have seen over the past four years. Additionally, with Starbucks estimating that three out of four new stores will be opened outside the United States – this represents a significant opportunity for Starbucks to bolster international revenues further. Given that we have seen growth in both ticket and transactions across this segment – the company is in a good position to diversify its revenue from North America – even though performance for the same remains strong in its own right.

In addition, store revenue is not the only source of revenue for Starbucks. Through a partnership with Nestle (OTCPK:NSRGY), we have seen that the company has become the leading at-home coffee leader in the United States by market share, and is also showing significant growth internationally. In this sense, I take the view that continued growth across this segment also has the capacity to counteract a potential short-term slowdown in store revenue.

Conclusion

To conclude, Starbucks Corporation has seen encouraging growth in revenue and transaction volume, and is trading at an attractive EV/EBITDA ratio. While the stock has seen downward pressure over concerns about sales growth – I take the view that sales growth in the most recent quarter has been encouraging.

For this reason, I take the view that the drop in the stock that we have been seeing is potentially an overreaction on the part of investors. In this regard, I revise my rating on the stock from hold to buy and take a long-term bullish view.