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Starbucks downgraded by Goldman Sachs on China concerns

Julia La Roche
Starbucks downgraded by Goldman Sachs on China concerns

Goldman Sachs lowered its price target on Starbucks (SBUX) stock and downgraded it to neutral from buy partly because of concerns about China.

"We remain reasonably confident that [Starbucks] initiatives to drive digital engagement outside of [My Starbucks Rewards] (and ultimately drive trade up into MSR) can drive a more stable 3-4% comp trajectory in the US over the next few ears; however, valuation has rapidly re-rated to reflect this, gift cards and digital trends could be points of caution in F1Q, and we have incremental concerns regarding China macro and the comp trajectory in that region," Goldman analyst Karen Holthouse wrote.

Goldman's 12-month price target now sits at $68, down from $75.

In the note, Holthouse pointed to Apple's (AAPL) recent announcement that it was lowering sales guidance for its fiscal first quarter, citing weakness in China and lower than expected iPhone demand.

"The recent [Apple] announcement (while potentially also product-driven) cited trade concerns/macro, and [Mcdonald's] (MCD) acknowledged softer trends in the region at a late," Holthouse wrote.

China is Starbucks’s second largest and fastest growing market. Starbucks operates 3,600 stores across more than 150 cities in mainland China. Starbucks opens a new store in China every 15 hours. The company's longtime CEO Howard Schultz, who left the company in June, once predicted that there would be twice as many Starbucks stores in China than the U.S. one day.

In recent years, more players have entered the coffee space, from small independent coffee shops to big companies like Coca-Cola (KO) and McDonald’s. Goldman pointed to growing competition in China, namely from Luckin, a Chinese coffee startup with ambitions to open 4,500 stores by the end of 2019. The competition in China is something that Starbucks' leadership has acknowledged in the past.

"The fact is that there is a large and growing addressable market around all things coffee," CEO Kevin Johnson said on the fourth quarter earnings call. "And as a company, we've been in this business for 47 plus years and built one of the world's most admired and trusted brands. And we've built that by delivering premium products and a premium experience in our stores. And that remains true today, the third place experience. And even as we've extended that to meet the need state of convenience, we work to do that in a way that is accretive to the brand and accretive to the experience in our stores."

As part of its strategy, Starbucks has focused on innovation in China, including partnering with e-commerce giant Alibaba (BABA) to offer delivery using The coffee giant also has a presence across the Alibaba ecosystem, including Hema, Tmall, Taobao, and Alipay.

The rollout of delivery in China has the potential to be a “meaningful offset to competitive pressures in China,” Holthouse noted.

Goldman also raised concerns about the sensitivity of China's comp store sales to earnings.

"At its December analyst day [Starbucks] offered long-term guidance for 1-3% China comps (versus prior long-term guidance of 3-5% globally, and a general view that China would be an outsized contributor to growth). Cannibalization was directly acknowledged as a factor, and we see room for this to drive incremental volatility as management has also acknowledged the difficulties predicting and measuring this against rapid changes in trade areas, and competition as additional factors," Holthouse wrote.

Starbucks has returned 54% since Goldman gave it a buy rating in December 2014, outpacing the S&P 500's 25% climb in that timeframe.

Starbucks will report fiscal first quarter earnings on January 24.

Correction: This article previously described Howard Schultz as Starbucks’s founder. The error has been corrected.

Julia La Roche is a finance reporter at Yahoo Finance. Follow her on Twitter.