Is Starbucks (SBUX) A Good Investment Despite Soft Sales?

We issued an updated research report on Starbucks Corporation (NASDAQ:SBUX) on Aug 17.

On Jul 21, Starbucks reported soft third-quarter fiscal 2016 results. Adjusted EPS of 49 cents per share were in line with the Zacks Consensus Estimate. Further, earnings grew 17% year over year as strong margins and lower-than-expected taxes mitigated the slow sales growth.

Though sales rose 7% year over year, it missed the Zacks Consensus Estimate. Sales were primarily hurt by a slowdown in comps and traffic trends. Global comps grew 4%, lower than 6% in the previous quarter, owing to a slowdown in traffic in the flagship U.S. market. The disruption due to the changes in the rewards program and its negative impact on one of the most popular yearly promotion - Frappuccino Happy Hour - impacted sales in the U.S. At the call, management also stated that the political uncertainty and the ‘’profound weakening in consumer confidence’’ has hurt overall restaurant traffic trends in the country.

Importantly, comps growth in the U.S. went down below 5%, ending its impressive streak of 25 straight quarters of comparable-store sales growth of 5% or greater. Third quarter comps were also weak in Europe and Japan.

Following the weak sales performance in the quarter, the company curtailed its full year issued sales and comps outlook.

However, the third quarter headwinds were mostly temporary and Starbucks expects U.S. comps to improve in the next quarter.

We believe that digital initiatives like mobile order/pay, delivery services along with third-party loyalty partnerships, food/beverage innovation, Starbucks Reserve premium coffees and Teavana tea can stimulate stronger sales trends in the Americas.

The coffee giant’s latest digital initiative, Mobile Order and Pay, is witnessing increased usage and could prove to be a key growth driver as its adoption increases. This initiative allows customers to order before arriving at a Starbucks café and pick up the items at their preferred Starbucks outlet, thus saving time. Mobile Order & Pay now represents nearly 5% of total U.S. transactions, close to 20% of all mobile payment at Starbucks.

Starbucks started food and beverage delivery through its employees at New York’s Empire State building last October. The company also began testing food and beverage delivery in collaboration with on-demand delivery service, Postmates, in a few areas of Seattle last December. These initiatives are anticipated to accelerate service, increase convenience and enhance customer loyalty, thereby driving mobile payment transactions and in turn, traffic.

Further, CPG growth across the world as well as international expansion will enhance value creation. Starbucks plans to sell Starbucks-branded Nespresso compatible pods/capsules in the U.S. and France later this year, thereby expanding its single-serve offering globally. The company recently launched ready-to-drink beverages in Latin America under its North American Coffee Partnership (NCAP) with PepsiCo, Inc. (NYSE:PEP) and has plans to launch the drinks in China with partner Tingyi by the end of this year. Starbucks also plans to bring Teavana ready-to-drink (RTD) tea in the U.S. in partnership with Anheuser-Busch InBev SA/NV (NYSE:BUD) in the first-half 2017.

However, accelerated global employee and digital investments can keep fiscal 2016 profits under strain. Over the past couple of quarters, higher employee expenses, particularly in the U.S., as well as digital investments put pressure on profits.

Zacks Rank and Stocks to Consider

Starbucks has a Zacks Rank #3 (Hold). A better-ranked stock in the restaurant sector is Del Taco Restaurants, Inc. (NASDAQ:TACO) with a Zacks Rank #2 (Buy).