Why Starbucks Corporation’s Dividend Will Quickly Double
February 14, 2017
It’s never a good idea to stereotype, even when it comes to stocks. Income investors, for example, might have completely ignored Starbucks Corporation (NASDAQ:SBUX) over the years due to the largely held belief that it remains a trendy, high-multiple-growth play and simply far too risky for most retirement accounts.
Well, if you’re in that boat, you might be surprised to know that Starbucks actually began paying a dividend since March 2010 and has increased it significantly every year since. So while Starbucks doesn’t have the generations-long dividend history of stalwarts like Johnson & Johnson (NYSE:JNJ) and Exxon Mobil Corporation (NYSE:XOM), the stock’s dividend growth potential alone should keep it very high on our dividend watch list. Of course, I can always just watch it for you.
Moreover, with SBUX stock having performed somewhat sluggishly of late—a return of just three percent over the past year versus the Dow’s 25% surge–now might be a tasty time to get in on that dividend growth inexpensively.
That is, of course, if the risks are worth it. Let’s take a closer look and see if they are.
Growth Gone Bad?
The biggest concern surrounding SBUX stock right now is that the company’s high-flying growth days might be behind it.
In the latest quarter, revenue increased just seven percent to $5.7 billion, easily missing the consensus by $120.0 million. Even more worrisome for investors was that global same-store sales (sales of locations open 13 months or longer) increased just three percent year-over-year versus five percent over the prior 12 months, forcing analysts to quickly recalibrate their growth expectations.
The first quarter results were especially disappointing, because just a few weeks earlier, Starbucks unveiled an ambitious–maybe even too ambitious–five-year plan to grow revenue and earnings per share at a rate of 10% and 15%–20%, respectively. And with founder, Chairman, and Chief Executive Officer Howard Schultz stepping down in a few months to focus on the company’s premium Reserve Roasteries, investors are scratching their heads as to how the company will even come close to those long-range targets.
However, I’d highly caution our Income Investors readers from making too much out of Starbucks’s Q1 results.
Why? Well, management blamed the weak sales largely on the rapid adoption of its Mobile Order and Pay (MOP) system, which allows customers to order ahead on the app and just head straight to store for pickup. But in the first quarter, customers would apparently walk into the store, see a ridiculously long line at the pickup counter, and then just walk out. Considering that MOP usage now makes up seven percent of Starbucks’ U.S. transactions, compared to only three percent a year ago, I’d say management’s reasons are valid.
So basically, Starbucks seems to be dealing with a problem that most companies would love to have: too much demand. Although bottlenecks are a real issue, I think it’s safe to say that Starbucks’ brand power isn’t deteriorating in the slightest. Also, I fully expect management to come up congestion-alleviating solutions, both in the near term (more baristas at the pickup counter) and long term (stand-alone MOP stations).
It’s no surprise, then, that management remains highly optimistic.
“Starbucks is engaging more deeply — and more frequently — and expanding its base of loyal customers faster and more consistently today than ever before,” said Schultz. “The trust and confidence our customers have in the Starbucks brand is fueling our flywheel and propelling our business forward in markets and channels all around the world.” (Source: “Starbucks Reports Record Holiday and Record Q1 FY17 Results,” Starbucks Corporation, January 26, 2017.)
Dividend Perking Up
Of course, as income-oriented investors, our main concern is whether or not Starbucks’ fundamentals can fuel long-term dividend payments. Well, as we just discussed, worries over the company’s growth rate might be a bit overblown–so much so, that I fully expect Starbucks to deliver double-digit dividend increases for many years.
As I mentioned earlier, SBUX stock has grown its dividend at a breakneck pace since its first payment in early 2010. Over the past five years, in fact, the company has hiked the dividend at an average annual rate of 24.7%. At that speed, the dividend would double in less than three years!
Now, it would be a bit highly optimistic to expect 25% dividend increases over the long run. But given Starbucks’ financial strength and growth potential, it wouldn’t surprise me at all if management ends up delivering dividend growth in the mid-to-high teens for a decade and beyond.
Over the past 12 months, Starbucks generated operating cash flow of $4.4 billion, with dividends of just $1.2 billion. That leaves plenty of room for bigger paydays down the road. And in terms of earnings, Starbucks’ payout ratio currently sits at just 44%. In other words, Starbucks isn’t even close to the point where it is paying out nearly all of its cash flow and earnings, like many dividend stalwarts do.
Of course, the biggest reason to be positive about Starbucks’ dividend growth lies in the company’s aggressive store expansion plans, with an aim to open 12,000 new locations within five years. That would boost the company’s worldwide store count by a whopping 50%.
What’s particularly noteworthy is the fact that 5,000 of those 12,000 locations will be opened in China, where Starbucks’ newest class of stores is generating the highest margins of any store type in the company’s history. In fact, Starbucks expects China to eventually surpass the U.S. as the company’s largest market.
The Bottom Line On SBUX Stock
Starbucks isn’t just a growth darling anymore. Rapid dividend increases in recent years, along with healthy share repurchases, have placed SBUX stock firmly on my income investing radar. But more importantly, Starbucks’ digital growth initiatives, mouth-watering international opportunities, and recent share price pullback have made the stock a timely dividend contender in my books.
Now, traditional value investors might continue to flinch at the stock’s 25-plus price-to-earnings multiple and remain unimpressed with its dividend yield of 1.8%. However, if Starbucks can simply meet its long-term growth objectives while doubling the dividend every five years or so, today’s price might end up looking like a screaming bargain in hindsight.
Given Starbucks’ still-undeniable brand power all over the globe, I’d say the chances of that are pretty high.
