Over the last five years, share prices of Starbucks(NASDAQ: SBUX) have nearly doubled and significantly outperformed the S&P 500 index. Still, there's good reason to expect another similar run of returns over the next five years.
Investors didn't like the company's sluggish sales in the last quarter, which led to a small sell-off. Revenue came in below expectations due to weakness in China, but one segment continues to show impressive growth that should keep the stock outperforming in 2023 and beyond.
Consumers are choosing Starbucks
The best barometer of Starbucks' brand is the growth in the channel development segment. This segment only makes up 5% of total revenue, but it includes the branded products that Starbucks offers with Nestlé(OTC: NSRGY)(OTC: NSRG.F) and other partners at retail locations outside of its company-operated and licensed stores.
| Segment | Fiscal Q1 2022 | Fiscal Q1 2023 | Change (YOY) |
|---|---|---|---|
| North America | $5.73 billion | $6.55 billion | 14% |
| International | $1.88 billion | $1.68 billion | (10)% |
| Channel development | $417 million | $478 million | 15% |
Data source: Starbucks. YOY = year over year.
Channel development revenue increased 15% year over year last quarter and has been the company's fastest-growing category coming out of the pandemic. The performance in the ready-to-drink business speaks to Starbucks' ability to reach new customers and expand brand awareness around the world.
In 2021, Starbucks and Nestlé announced a new effort to bring branded ready-to-drink beverages to parts of Southeast Asia, Oceania, and Latin America. It was during a fiscal Q3 earnings call in August 2022 that management told investors it was in the very early stages of the opportunity with Nestlé.
In fact, CEO Howard Schultz called the partnership with Nestlé "a massive global opportunity." He also said, "Looking ahead, we expect to see a closer Starbucks-Nestlé partnership. This includes introduction of Starbucks varietals onto Nespresso's digital sales platform, a channel that does not presently exist for us."
Starbucks ended up growing its channel development revenue by 16% in fiscal 2022 ending in September. It's the company's most profitable business, generating a high operating margin of 44%.
The ready-to-drink market is very competitive. Starbucks is putting its branded products on retail store shelves next to well-established consumer brands, and it's even selling its products on Amazon's e-commerce site. It's competing for customers that may not visit a Starbucks coffee shop on a regular basis. But its success here shows that the brand is standing out in a crowded marketplace, which is very important and speaks to the company's ability to sustain revenue growth for many years.
SBUX Revenue (Quarterly) data by YCharts
A sweet deal
The Nestlé partnership not only is helping Starbucks expand its presence outside of its store locations, but from a business perspective, it's also an incredibly attractive deal, since the coffee specialist doesn't have to spend a lot of capital on the supply chain. Instead, it can piggyback on Nestlé's vast distribution capabilities worldwide.
The expansion of the channel development segment will clearly benefit Starbucks' earnings growth, given its incredibly high margins. Analysts currently expect the company to increase earnings by nearly 18% per year on an annualized basis through 2027.
These growth expectations are partly why Starbucks already trades at a premium valuation. Still, the stock is probably worth paying up for right now. There are a few catalysts on the horizon, including a reopening of China's economy, which will turn a revenue headwind into a tailwind later this year. That will come on top of strong momentum in the ready-to-drink market, which should make the stock a relatively safe holding for 2023.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. John Ballard has positions in Amazon.com. The Motley Fool has positions in and recommends Amazon.com and Starbucks. The Motley Fool recommends Nestlé and recommends the following options: short April 2023 $100 calls on Starbucks. The Motley Fool has a disclosure policy.
