China's economic difficulties have had a negative impact on Starbucks' stock performance this year, leading some investors to suggest that the company should consider spinning off its Chinese division in order to rejuvenate its shares.
However, one analyst disagrees with this approach.
In a note to clients on Thursday, Citi analyst Jon Tower expressed his belief that a spin-off would not significantly increase the company's value. Tower adjusted his price target to $100 from $104 while maintaining a Neutral rating.
Starbucks has made substantial investments to establish a strong presence in the Chinese market. With plans to expand to 9,000 stores by 2025, the company already operates over 6,400 stores in China. In fiscal 2022, China accounted for 9% of Starbucks' total revenue, making it the company's largest market outside of the U.S.
Unfortunately, Starbucks' efforts in China have not yielded the desired results. The company's stock has declined by 7.5% this year, underperforming the 11% gain of the S&P 500 index. Concerns about China's slow economic recovery and increased competition from local and international chains have exerted downward pressure on the stock.
Tower emphasized that Starbucks needs to acknowledge these challenges and make appropriate strategic adjustments. However, he cautioned against taking the route of transforming the Chinese division into a separate entity, as Yum China has done. Tower does not believe this approach would be effective in reviving the stock.
As Starbucks grapples with its performance in China, investors are eager to see how the company will navigate these obstacles.
The Small yet Influential Chinese Business of Starbucks
According to Tower estimates, the Chinese business constitutes only about 6% of Starbucks' earnings before interest and taxes. While this portion may seem relatively small, it still plays a significant role in the company's overall valuation and stock price.
However, there are some challenges that a potential spin-off of the Chinese business would face. Tower points out that the stand-alone entity would not be self-sustaining in its current state. The investments required for its growth would likely surpass the cash flow generated in the country. This implies that the stand-alone enterprise would operate with a negative cash flow. As a result, investors tend to assign lower valuations to such companies, primarily due to their greater volatility.
Starbucks, when approached for comment, did not respond immediately.
Looking ahead, Starbucks is scheduled to report its earnings on November 2nd. On the same day, the company has organized an investor event, which will be hosted for the first time by the new CEO, Laxman Narasimhan. Tower suggests that this event could serve as an opportunity for Starbucks to address concerns, including the recovery in China and overall macroeconomic risks.
Tower further adds, "The event does give some opportunity to 'dream the dream' in relation to China and potential cost optimization."