Investing.com -- Shares of Starbucks Corporation (NASDAQ:SBUX) fell in pre-market trading on Tuesday following a downgrade by Jefferies, which cut its rating on the coffee giant to "underperform" from "hold."
The brokerage argued that the recent rally, sparked by the appointment of new CEO Brian Niccol, has been "overdone," citing concerns about the challenges Starbucks faced in turning around its business.
The downgrade has sent waves through the market as investors reconsider the stock's valuation amidst growing uncertainties.
Jefferies analysts stated that while Niccol’s leadership and strategic change have been well-received, the stock’s nearly 27% gain since his appointment may be premature given the significant operational and cultural issues still facing the company.
“We find this gain to be too much too soon when very little is known about Mr. Niccol's plans so early in his tenure, which just began weeks ago. We find the culture, human capital and market positioning of the SBUX brand as challenged, and this turn, given its size, complexity and global scale (what to do with China is not considered in this work at this point), will take a significant amount of time and investment, in our view,” the analysts said.
Jefferies expressed concern that Starbucks' current valuation, trading at 25x forward earnings, is out of step with its global quick-service restaurant peers, such as McDonald’s (NYSE:MCD) and Yum! Brands (NYSE:YUM), which trade at 23.5x forward price-to-earnings ratios.
The analysts noted that Starbucks' premium valuation is unwarranted given its slower expected growth trajectory, calling for a valuation more aligned with the peer average of 21x two-year forward earnings.
The report also flagged expectations for Starbucks' fiscal 2025 guidance to be a major disappointment. Jefferies projects low single-digit EPS growth for fiscal 2025, far below the consensus estimate of 11-12%.
They expect U.S. same-store sales to decline by 4%, with international markets, including China, facing similarly negative trends due to a challenging macroeconomic environment.
The brokerage lowered its price target for Starbucks to $76 from $80, implying about 20% downside from current levels.
While Jefferies praised Niccol’s leadership abilities, they cautioned that his turnaround of Starbucks will be more complex and prolonged compared to his success at Chipotle Mexican Grill (NYSE:CMG).
Starbucks is grappling with deep-seated issues, including operational inefficiencies, cultural challenges, and a declining value perception among customers, particularly in the U.S.
These issues, as per Jefferies, will take time to address and could weigh heavily on Starbucks' near-term performance.
“4Q EPS on Oct. 30 is not going to be good, in our view, as we lower our US SSS ests as the business does not seem to be in a position where it is even responding to the tried and true Pumpkin Spice Latte (and all else Fall) launch in late Aug,” the analysts said.
Investing.com -- They also noted that upcoming announcements from management, including fiscal 2024 results and fiscal 2025 guidance, are likely to add to the uncertainty, with Jefferies viewing fiscal 2025 as a potential “throwaway” year focused on reinvestment and stabilization rather than growth.
Jefferies further suggested that Starbucks may need to lower its long-term growth algorithm to reflect more realistic expectations, particularly in the U.S. and China, which comprise the majority of its growth.
The brokerage believes that Starbucks' 7% global unit growth target is at risk and that a more feasible target would be closer to 5%, accompanied by low single-digit same-store sales growth.
Jefferies also sees the company’s pursuit of 15%+ long-term EPS growth as unrealistic. They suggested that a more modest outlook of 10-12% EPS growth would be more achievable, aligning with global QSR peers like McDonald’s and Domino’s Pizza (NYSE:DPZ), which operate more asset-lite business models with greater flexibility.
While the market had initially reacted favorably to the leadership change, Jefferies' downgrade and cautious outlook underscore the tough road ahead for Starbucks.
The stock, which had seen a significant rally following Niccol’s appointment, now faces heightened scrutiny as investors digest the challenges of stabilizing and growing the business.
Jefferies' price target of $76 suggests substantial downside, and until Starbucks' fundamentals show signs of improvement, the stock may struggle to regain momentum.
Starbucks was trading 1.7% lower in pre-open trade on Tuesday.