Shares of Starbucks Corp. (SBUX) have had a nice run so far in 2017, up about 9 percent. But they are well off their highs around $64.50 on June 2,  falling to about $60.90 as of the close on June 13. Wedbush threw cold water on Starbucks on Wednesday, downgrading it to neutral from outperform but left the price target unchanged at $65. The reasoning for the downgrade was that U.S. same store comparable sales were running in line with expectations at best, and raises an important question: Have the shares moved too far ahead of the company's fundamentals?

Deflating Starbucks Bulls

These weak same-store sales potentially endanger the bulls' thesis that Starbucks is on the cusp of a rebound, and it helps to explain why the stock has been struggling. The news also raises the question of whether Starbucks can offset anemic growth in the U.S., which still accounts for a nearly 70 percent of sales. The company's P/E of nearly 28 indicates investors are betting heavily that the company's growth will accelerate. 

Starbucks performance vs. the S&P 500 since January 2016

SBUX data by YCharts

The stock has not performed well over the past two years. Since January 1, 2016 shares of Starbucks are up only 3.7 percent, dramatically lagging the S&P 500, which is up 21.25 percent. You can see why some investors in Starbucks might be excited about a potential pick-up in sales. The question is when that will happen.

As discussed in previous Investopedia stories, the company is depending on profit and revenue growth from mobile payments in the U.S. and from expanding into Asia. For Starbucks, quarterly consolidated same store comps have been declining for a very long time as Starbucks grows bigger in size, as you can see by this chart below.

Starbucks quarterly consolidated same store comps

The company's expanding mobile payments system and other steps are aimed at boosting efficiency and thus gross margins, which have been slipping.  

starbucks quarterly gross margins

Beyond mobile payments, the second leg of growth for Starbucks will again need to come from the Asia/Pacific region, where the company is growing rapidly. In the fourth quarter of 2010, there were a total of 2,580 stores, as of second quarter 2017 that number surged by nearly 170 percent to 6,933 stores, versus 16,058 U.S. stores. 

Chart showing the number of Starbucks stores in Asia as a percent of the total is increasing sharply since 2010.

The store openings in Asia/Pacific are driving revenue higher as well. Revenue in Asia as a percent of the firm's total revenue rose from 5.8 percent in 2010 to 13.62 in 2016, while revenue in the Americas has fallen from 79 percent to 69 percent. 

The latest downgrade from Wedbush illustrates the major challenges ahead for Starbucks. If it fails to accelerate comparable store growth in the U.S., it will need other avenues - mobile payments and Asia growth - to offset it. The company's level of success in doing that will determine whether Starbucks outperforms the market as it once did, or remains a market laggard. 

Michael Kramer and the clients of Mott Capital Management LLC own shares of SBUX

Michael Kramer is the Founder and Portfolio Manager of Mott Capital Management LLC, a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendation made during the past twelve months. Past performance is not indicative of future performance.

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