Economic Headwinds Not a Threat to Starbucks' Dividend

Starbucks shares have fallen nearly 40% this year as inflation and Covid-related lockdowns in China have weighed on the company's profitability and outlook. 

With no clear end to these economic obstacles, Starbucks has removed guidance for the back half of this fiscal year despite confidence these issues will eventually wane. 

While Starbucks may need to endure a few more challenging quarters, we believe the company's long-term outlook is unchanged, and the dividend remains safe.

That said, inflation remains a concern and has been felt more acutely by Starbucks than some retailers because the coffee chain giant generates most of its revenue from company-owned stores rather than licensed or franchised stores.

This operating model makes Starbucks fully responsible for higher freight, commodity, and labor costs until they can be pushed on to customers in the form of higher prices.

Although sales grew 15% last quarter, costs rose at an even brisker pace, resulting in Starbucks' operating margins shrinking from 16% to 13%.

But with a highly-regarded premium brand and as the largest coffee purveyor in America, Starbucks is better positioned than most to keep raising prices to protect its margins.

On top of inflationary concerns are government-mandated lockdowns that have temporarily shuttered about one-third of Starbucks locations in China – a country expected to be a key driver of the company's long-term growth.

After years of rapid expansion, China now accounts for nearly one-third of Starbucks' company-owned stores and is expected to one day outpace U.S. sales as premium coffee consumption rises alongside a growing middle class.

While ongoing pandemic disruptions, slowing economic growth, and growing political tension between the U.S. and China create a murkier outlook for Starbucks, these factors seem unlikely to alter the long-term growth opportunity in China or the firm's leading market share position.

And while China is notably important to the company's outlook, Starbucks' international sales were up 4% last quarter despite a 14% sales slump in China, underscoring the company's global reach and growth opportunities in other countries.

Looking ahead, Howard Schultz returned as Starbucks' temporary CEO in April for his third management stint at the company. One of his first actions was suspending share repurchases to invest more in labor and store innovations, further strengthening Starbucks' advantages in customer service and providing a unique coffee shop experience.

While suspending buybacks may sound like Starbucks is one step closer to cutting its dividend, we expect the payout to remain safe. Starbucks continues to maintain an investment-grade balance sheet and a reasonable payout ratio near 60%.

The company has historically announced its annual dividend raise in September. We believe Starbucks could increase its payout for a 12th consecutive year despite the challenging backdrop, but any raise will likely be more modest than last year's 8.9% boost.

Overall, inflation and China's Covid restrictions will likely prove transitory and shouldn't affect Starbucks' brand loyalty, long-term strategy, or dividend profile. As such, we are reaffirming Starbucks Safe Dividend Safety Score.

Starbucks continues to be viewed globally as a premium brand worth the premium price, providing opportunities to expand the business in countries like China with a growing middle class. 

Investors confident in the long-term strength of the Starbucks brand and its continued international expansion may find now an interesting time to consider ownership, with the stock's dividend yield sitting near a five-year high of over 2.5%.

We will continue monitoring Starbucks' performance and provide updates if needed.

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