2 Reasons Investors Poured Cold Brew All Over Starbucks Stock Following Earnings

At first glance, one might have thought that the Starbucks (NASDAQ: SBUX) earnings report would go over like a hot, smooth jolt of espresso. Instead, stockholders treated it like a stale, chilly cup of cold brew.

The company experienced massive year-over-year sales increases and even reported 10% comparable sales growth over two years, signaling a recovery from the pandemic. Nonetheless, the state of its primary growth market and a closer look at Starbucks stock itself could make investors jumpy.

A masked barista stands behind the counter in a coffee shop.

Image source: Getty Images.

The Starbucks earnings report

The company reported record net revenue for the third quarter of 2021 of $7.5 billion. This came in 78% higher than the same quarter last year, though much of the country remained locked down during the year-ago quarter. Also, the company improved on the Q3 2020 loss of $678 million, reporting a net income of just under $1.2 billion. The fact that operating expenses grew by only 22% during that period helped Starbucks deliver a profitable quarter.

Moreover, the company addressed some potential headwinds. On the Q3 2021 earnings call, president and CEO Kevin Johnson emphasized that neither cold weather impacting the coffee crop in Brazil nor rising wages amid the recovery have stopped growth. He also said that leveraging the company's pricing power to sell more premium brands could compensate for these rising costs.

Nonetheless, a closer look at the report gave investors a painful headache instead of a caffeine-induced high. As a result, Starbucks' stock price fell by just under 3%, closing at just above $122 a share at the end of Wednesday trading. This drop likely occurred for two reasons.

1. Worries about performance in China

The first and primary reason is likely the company's performance in China. Like the overall results, the China numbers appear impressive at first glance. The store count in China reached just over 5,100 stores at the end of the quarter, accounting for about 15% of the just over 33,000 locations Starbucks operates globally. This increased from about 4,400 one year ago. Also, the 19% increase in comparable-store sales for China hardly looks weak.

However, China has long served as the company's primary growth market. It accounted for almost 700 of the 1,115 net store additions over the last year, about 62% of the total.

Despite this, Starbucks' Chinese stores dramatically underperformed its locations in the U.S., which experienced comparable-store sales growth of 83%. Even worse, for Q4, the company projects "roughly flat" comparable-store sales increases in China, during a time that it forecasts between 18% and 21% growth globally.

On the earnings call, Johnson also said that geopolitical concerns had not impacted the company in China, and he said Starbucks had a goal of 6,000 stores in the country by the end of fiscal 2022. Johnson described any possible effects from COVID-19 as "short-term." However, none of that appeared to satisfy investors, who subsequently sold Starbucks stock on the news.

2. The state of Starbucks' stock

Another problem for Starbucks' stock is that it didn't price in bad news. Its price had risen by about 65% over the last year and traded at record highs before the earnings announcement:

SBUX Chart

SBUX data by YCharts.

This increase had taken its price-to-earnings (P/E) ratio to just above 50, which appears pricey for a stock that had rarely exceeded a 35 multiple between 2015 and mid-2020. Moreover, the price-to-sales (P/S) ratio now stands at around 5.4; before the pandemic, the P/S ratio had been between 3 and 4 for most of the last 10 years. Given the current struggles in its most important growth market and this frothy valuation, investors may show less willingness to open new positions.

Where does this leave Starbucks?

Admittedly, none of the current challenges appear to undermine the company's long-term prospects. No obstacles seem to have appeared that would stop Starbucks from reaching its goal of 6,000 stores in China by September 2022. Additionally, the increased sales over two years confirm that it remains on a growth trajectory globally.

However, with valuations above historical norms, and its primary growth market bracing for stagnant comparable sales increases, investors may want to avoid adding positions in this restaurant stock in the near term.

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Will Healy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Starbucks. The Motley Fool recommends the following options: short July 2021 $120 calls on Starbucks. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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