Editor's Note: Below is a recent research note written by our Restaurants analyst team. For more info on our institutional research email sales@hedgeye.com.
Starbucks (SBUX) is on the Hedgeye Restaurants Best Ideas list as a SHORT
HEDGEYE OPINION
The SBUX activism story is gaining traction as the stock has underperformed the S&P by 38% and 23% over the last 1 and 3 years, respectively. On a 5-year basis the stock has outperformed the S&P 500 by 1%, but this is not enough to keep the activist rumors from coming up from time to time.
We believe the best thing that could ever happen to the SBUX CEO, Kevin Johnson, is for an activist to appear! Given the current state of the business (maintaining a complex growth profile, while trying to fix the business), is a recipe for failure, and could potentially mean that Kevin Johnson will not be the CEO of the company by fiscal year 2020.
On the other hand, his tenure could be extended if a large vocal shareholder appears and presses the Board to alter its capital allocation policies. As you probably know, shareholder activism in the restaurant space is very straight forward. Traditionally, there are only a few changes you can make to a restaurant business model that creates significant shareholder value. The biggest change that creates the most shareholder value is to slow growth, to allow for operational improvements and improve the return on incremental invested capital (ROIIC). For an activist with a short-term window, this is a much harder pitch to make and can take time to implement.
The typical Restaurant activist playbook looks something like this:
- Sell non-core assets
- Streamline G&A
- Sell-company owned stores to become an asset-light model
- Sell real estate
- Increase leverage and pay a big dividend or buy back stock
On the surface there is not a lot to do at Starbucks, as there is no real estate or non-core assets to sell. Given the strong ROI on new stores, the implications of becoming an assets-light model would be disastrous for the stock. Therefore, the only real opportunity for an activist is to push Starbucks management to slow new unit growth (cut capital spending) and reduce G&A. To simplify, this is part of our short thesis on SBUX. We believe the aggressive growth in capital spending over the past nine years has created significant issues for the company, among other things. Yes, this is a movie we have seen play out in the Restaurant space dozens of times, and once before with Starbucks.
Frankly, I just think it’s too early for an activist to get involved, because there has not been enough pain inflicted on shareholders yet. That does not mean a “Jana like” fund will not take a position to establish a dialog with management and push for change. This strategy would be very expensive and management might not listen. Currently, a 3-5% position in SBUX will cost you between $2-$4 billion, and this price tag limits the potential number of players that could get involved. Any position smaller than $2.0 billion is just noise, just like the Barron’s article over the weekend. The only thing the Barron’s article accomplished was to give the magazine the right to say they wrote about a potential activist before it happened and to get me to write a note about the company.
