Bill Ackman may be onto something.
The activist investor, and founder and CEO of hedge fund Pershing Square Capital Management, disclosed Tuesday Oct. 10, that his fund currently holds a 1.4% stake in Starbucks Corp. (SBUX - Get Report) . The stock immediately popped more than 3% on the news, and settled 2% higher on the day.
Ackman's stake could be a positive indicator for those already in the stock. "Obviously it means a little bit of support," JJ Kinahan, chief market strategist at TD Ameritrade, told TheStreet. "You see how much he bought -- if you're somebody who already holds it, you're feeling a lot better about your investment."
There are reasons to buy Starbucks, mainly because of opportunity in both the U.S. and China. While a few key risks could emerge, Ackman makes a valid point in buying Starbucks.
"The crux of what's being pointed out by Pershing is that Starbucks is interesting from a valuation perspective, and what they're doing to reevaluate the U.S. business," said Markus Hansen, senior analyst at Vontobel Quality Growth Asset Management.
"The stock has significant upside over time," he added.
Ackman may have found a value stock, as Starbucks is trading at a price-to-earnings ratio of 18, perhaps more compelling than the average P/E ratio for S&P 500 companies of 23. "Ackman is pointing out correctly that the share price has done nothing," Hansen said.
Indeed, the stock is down about 0.7% this year, as its U.S. sales have essentially flatlined, growing at 1% year over year in the July quarter, down from 2% in the previous quarter. Hansen, along with Ackman, said he think Starbucks has to get back on its feet in the U.S., and that management is pulling the right strings to get there. Others agreed.
"Bill Ackman's position could be more passive as Starbucks is in the process of taking steps to improve their business," said Cynthia Frick, senior equity analyst at USAA. "The company needs to drive traffic increases in the U.S." The United States represents about 70% of Starbucks' revenue.
A Revamped U.S. Business Can Get Back on Its Feet
"Management is doing all the right things," Hansen said. He said Starbucks should be looking to return to roughly 3% sales growth in the U.S., which is in line with Statista's estimate that broader U.S. coffee sales will grow about that for the next several years. The coffee chain could be on the road to achieving that growth.
The company's mobile app is an important piece to the puzzle. "The way we shop now has changed, and Starbucks has embraced that," Hansen said. After tech problems on the app burdened the customer experience and speed of sales, Starbucks had to go back to the drawing board on the app, and Hansen believes the new CEO Kevin Johnson is a big reason why the app has become efficient again. "Kevin Johnson has been the right guy on the technology change," he said. Hansen also mentioned Starbucks' recent turn to healthier drinks, which customers have recently indicated they like.
Still, the economic cycle looms as a potential headwind. Many believe the U.S. is nearing the peak of the economic boom. Consumer discretionary stocks usually don't perform well as consumer spending ticks downward. "If you think the economy is gonna slow, that's a definite risk," Kinahan said. "If the economy slows down, people will bring in the reins, and this is an area where they feel like they can save." Starbucks offers slightly pricier coffee than the competition. While Starbucks isn't insanely expensive, an economic downturn could chase consumers wallets toward cheaper coffee. "If you think we're having a slowdown period, people will choose more of a Dunkin' (DNKN - Get Report) , etc," Kinahan added.
China Business Could Grow Explosively
Investors and analysts also have their eyes on the China opportunity. "That's a huge country, so many people," Kinahan said. "The number of shops there compared to the population in some of the cities, there are expansion opportunities." That's exactly Hansen's thesis as well. "China is a great long-term growth boost for the company," Hansen said.
Starbucks has about 3,000 locations in China, but it could get to 6,000 stores, Hansen said. Regarding population growth, Hansen said there about 300 million millennials in China currently, which is Starbucks' main demographic. That number could get to 450 million by 2023, a 50% increase, Hansen noted.
Still, Starbucks will have to boost U.S. sales, Hansen said. That sales growth could come from changes that Starbucks has made in the U.S. Hansen, whose firm holds Starbucks for its clients, said, "My guess is we start to see the fruits of that going into the beginning of next year."
"We're in for the long term," he added.
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