Now that the second quarter of 2024 earnings season is underway, and most of the bigger consumer discretionary names are out in the spotlight reporting how their businesses have done so far into the first half of the year, investors must understand where the future valuations of this sector may be headed. While not as popular and hyped up as the technology sector, there is still merit to some of the names.
One of these stocks is Starbucks Co. (NASDAQ: SBUX). Shares of the coffee giant are rallying by as much as 6.5% in the after-market hours of Wednesday evening, a reaction that is accredited to a stellar quarterly report from the company—a most awaited one at that, particularly after the stock declined by over 35% from its 52-week high, leaving investors with high hopes to see the fundamentals turn around.
The wait might be over, and markets may be right in making their initial view of earnings public. Starbucks showcased some recovery signs and set the tone for a new path for the rest of 2024. With a double-digit upside forecast, Wall Street analysts who are already bullish might want to renew their optimism soon after markets digest all of Starbucks’s results.
Starbucks Earnings Reveal Why It's the Perfect Stock for a Market Rotation
While Starbucks' revenue might not have been the best, as it was only up 1% on the year to underperform inflation and GDP growth, zooming in can lead investors to spot awakening momentum. Every quarter, revenues were actually up by 6%.
The sudden turn in revenue is driven by Starbucks's current over 33.8 million rewards membership users, a metric that grew by 7% year over year.
The importance of this growth is amplified considering that the past 12 months were filled with consumer concerns over inflation and other rising costs of living, so choosing to stick with Starbucks means something.
That is called pricing power and market penetration, which can be quantified. Starbucks has an impressive gross margin rate of over 27%, better than most in the retail sector. Starbucks achieves this through qualitative factors in both pricing power and brand moat.
This is also why, even though net revenues were relatively flat over the year, the average ticket price in stores rose by 3%. While volumes may have dropped off, people are still willing to pay 3% more at the counter. Investors could potentially take this as a sign that bad—or stagnant—customers are being rinsed out while better ones stick around.
Now, some in the market may be confused by the following divergence: If earnings per share (EPS) are down by 6.1% in the year, how come Starbucks stock rallies by roughly the same amount after the announcement?
And that's where proper financial analysis comes in handy.
Starbucks Financials Point to a Brighter Forecast
Starbucks stock is rallying despite a decline in EPS due to free cash flow (operating cash flow minus capital expenditures). In the same quarter of 2023, the company reported $2.4 billion in free cash flow. Fast-forward to today’s quarter, Starbucks had $2.5 billion in free cash flow.
As this metric is a proxy for net income, investors can see how the core operating results in Starbucks stock actually show some growth rather than the contraction suggested by EPS. However positive this may sound, it is in the rearview mirror, and investors cannot monetize the past.
Management hinted that both Main Street and Wall Street should take home. This quarter, $1.2 billion was allocated toward buying back stock, taking out as many as 15 million shares from the open market.
Stock buybacks typically mean that management believes a stock is on the cheap and could rally in a relatively short period. Keeping the insider bias aside, here’s how Wall Street feels about the stock.
The consensus forecast for 11.8% EPS growth in the next 12 months is good, but it’s not a 6.5% rally after earnings. The better part of the deal comes through price targets, and those at BMO Capital Markets felt comfortable making their bullish views public.
Those analysts value Starbucks stock at $100 a share, daring it to rally by up to 31.8% from its current price. Based on Wall Street sentiment and recent financial momentum, Starbucks could be a top choice inside the Consumer Discretionary Select Sector SPDR Fund (NYSEARCA: XLY).
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
