Strong momentum despite inflationary pressures

Iconic Seattle-based coffee company, Starbucks Corporation (SBUX) owns and franchises more than 34,600 stores worldwide. The company has been particularly affected in the midst of the pandemic, as its operations and opening conditions have been disrupted. As a result, fiscal 2020 revenue was $23.5 billion, down from $26.5 billion in fiscal 2019. In fiscal 2021, the growth trajectory of the business picked up, with revenue hitting a new all-time high of $29.0 billion.

Starbucks’ recovery momentum continued as the company entered fiscal 2022, when it reported the best first quarter results in its history. Still, the company’s shares have struggled lately, having lost a third of their value in the past year. In fact, Starbucks shares are currently hovering at the same levels as they were in mid-2019.

In my opinion, Starbucks remains one of the best choices when it comes to dividend growth. As a result, the recent pullback could present a fruitful opportunity, especially for dividend-growing investors who previously avoided the stock due to its risk profile.

Along with Starbucks’ financials and dividend growth outlook that remain strong, in fact, the dividend yield currently hovers around 2.5%, which is at the high end of the stock’s historical range.

I remain bullish on Starbucks.

Driving through difficulties

Starbucks released second-quarter fiscal 2022 results, which retained the company’s recovery momentum. Revenue increased 15% year over year to $7.6 billion. The results were primarily driven by 17% revenue growth in the US and strong performance across its extensive portfolio of sites globally.

The company’s results also demonstrate the strength of its brand, despite the underlying challenges. These include the invasion of Ukraine, macroeconomic tensions, concerns about consumer purchasing power and high levels of inflation. While it’s debatable how these factors might affect Starbucks’ results, remember that Starbucks coffees are considered a premium product in the industry and come at a premium. So any weakness in consumer purchasing power could easily be reflected in the underlying numbers.

Impressively, the case appeared to be completely upside down in its latest results. Despite the growth in revenue compared to figures already recovered from last year, sales volumes have actually increased given the increase in prices.

Specifically, North America generated $5.4 billion in revenue for the quarter, suggesting a 17% year-over-year increase. The increase included a 12% gain in same-store sales, comprised of a 7% increase in average ticket and a 5% increase in transactions.

As management mentioned on the earnings call, the company’s average ticket hit an all-time high, fueled by strategic beverage pricing and another record quarter of food-related beverage sales. In fact, food sales are up 25% year over year. Along with this indication that consumer spending power remains strong, it also highlights the value of the Starbucks brand and its ability to significantly increase prices which are accretive to earnings.

Even so, inflationary forces have offset the company’s price increases. Operating margins decreased by 520 basis points. This drop included better salaries for store partners and the training of new partners. Overlapping government grants from the previous year also contributed to the decline. Earnings per share rose 3.6% to $0.58, partially boosted by a lower number of shares, however.

Dividend valuation and growth

Due to the uncertainty surrounding additional mobility restrictions and lockdowns in China resulting from the government’s strict Zero COVID policies as well as inflationary headwinds, the company has not provided specific guidance. However, consensus EPS estimates for fiscal 2022 point to $2.87.

This implies a P/E of 27.6 at current stock price levels, which is admittedly an expensive multiple in a rising rate environment. However, there are two factors to consider that could justify it. First, revenue growth remains in the double digits. Second, margins should increase once inflation subsides. These two factors combined should result in an EPS CAGR north of 20% in the coming years, analysts say.

Robust EPS growth in the coming years should also help maintain Starbucks’ strong dividend growth momentum.

Starbucks’ five-year DPS CAGR is currently close to 15%. The most recent increase in September was 8.9% at a quarterly rate of $0.49. According to management’s indications, this implies a payout ratio close to 68%. The ratio seems somewhat worrying. However, we stress that this is due to the continued contraction of margins and that it should normalize from next year.

The Taking of Wall Street

On Wall Street, Starbucks has a Moderate Buy consensus rating based on 12 buys and nine takes over the past three months. At $93.62, Starbucks’ average price target implies an upside potential of 18.09% over the next 12 months.

Conclusion

Starbucks is currently trading at the same levels as over three years ago. However, multiple advancements have since taken place, including the company’s revenue reaching new all-time highs. As inflationary pressures squeeze this year’s profitability, the company’s pricing power is proving fantastic.

Shares might look a little pricey, although valuation should normalize once margins return to their historical average. In the meantime, Starbucks’ yield is at the top of its 10-year range and the company’s dividend growth outlook remains. Therefore, dividend growth investors may consider Starbucks for their portfolios.

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