The Ratings Game: Starbucks is investing big in labor, which is putting pressure on margins and driving down shares but getting analyst support

Starbucks Corp. is making big investments in labor, which analysts say is putting pressure on the coffee giant’s margins, but is ultimately money well spent.


Chief Executive Kevin Johnson said during the late Thursday earnings call that workers with multiple years of service can expect raises of up to 10% coming in January. And next summer, hourly-wage earners will make an average of $17 per hour with barista wages to range from $15 to $23.

“In total, the FY 2021 and FY 2022 investments represent approximately $1 billion in incremental annual wages and benefits,” Johnson said, according to a FactSet transcript.

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Stifel analysts downgraded Starbucks to hold from buy on Friday, citing the pressures that the company is under.

“Nearly one year ago, we argued the company would improve its performance more quickly than investors anticipated, leading to earnings upside,” analysts said in a note.

“At this point, that thesis has played out, and the company now grapples with significant inflationary pressures and investments that are weighing on the margin outlook. Given the magnitude of the cost pressure, we struggle to argue enough price can be taken to offset the headwinds in the business entirely or that inflation will diminish over the next few quarters.”

Stifel lowered its price target to $112 from $130.

Starbucks reported fiscal fourth-quarter profit that beat expectations, but sales fell short.

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The stock tumbled 7.2% in afternoon trading Friday, and were headed for the lowest close since March 24. The stock was also on track to suffer the biggest one-day decline since dropped 8.2% on June 11, 2020, and the biggest post-earnings selloff since it slumped 9.1% on June 20, 2018 following fiscal third-quarter results.

“We maintain our outperform rating despite pressure on FY22 profitability, as we see continued investment in labor as the right strategy for the long term, with valuation support from accelerating development and increased capital returns,” wrote RBC Capital Markets.

Analysts cut their price target to $124 from $131.

“Ultimately, we view Starbucks’ continued investment in its employees as inextricably tied to its core strategy of delivering a premium experience to guests, and as likely the right move for the business over the long term, but we also expect ongoing debate around margins, well into FY22 and beyond,” wrote analysts led by Christopher Carril.

“In the meantime, stepped-up capital returns to shareholders via repurchases and dividends ($20 billion in total over the next three years) and accelerating development (to ~2,000 net new stores in FY22, or +6% year-over-year) should provide multiple support, in our view,” RBC analysts wrote.

Meanwhile, UBS analysts maintained their neutral stock rating but cut their price target to $115 from $125.

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“Starbucks’ underlying sales momentum in key markets, recent investments and
pricing power will help the brand emerge post-pandemic better positioned, but we
remain cautious on margin impacts and recovery trajectory,” wrote analysts led by Dennis Geiger.

UBS notes the big drivers behind Starbucks’ business, including its 24.8 million rewards members, cold beverages, which accounted for 75% of fourth-quarter sales, and higher average check.

Starbucks says it’s prepared for the holidays with seasonal inventory ready for purchase and an anticipated $3 billion to be loaded on Starbucks cards.

“As we consider the level of investments, the potential need for sales volumes to recover and/or generate productivity gains to offset inflation within a challenging environment uncertainty remains in play before determining what Starbucks’ shares’ true north is,” wrote MKM Partners in a note

MKM rates Starbucks shares neutral with a $114 fair value estimate, down from $130.

“We maintain confidence in SBUX’s ability to execute its game plan, to take share from its competitive set, and return to its more consistent top-line, earnings flow-through, and capital return model, in the coming quarters/years,” analysts said.

Starbucks shares are down 1.9% for the year to date while the S&P 500 index

has gained 22.4% for the period.

This post was originally published on Market Watch

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