By Al Root

On Tuesday, Starbucks preannounced terrible quarterly results, suspended financial guidance -- and raised its dividend. That's not how this is supposed to work, but it may explain why the stock rose 0.9% after the bad news was released.

And the numbers Starbucks released were bad. For its fiscal fourth quarter ended in September, comparable-store sales sank 7% year over year, worse than the 3% drop in the previous quarter. In the U.S., comparable transaction volumes sank a brutal 10%. What's more, earnings per share based on generally accepted accounting principles came in at 80 cents. Wall Street was looking for closer to $1, according to FactSet.

Investors didn't seem sure how to react to it all. Starbucks shares opened down about 3% on Wednesday -- already a small decline given the size of the miss -- only to finish the day higher. The dividend might be offering some support. Starbucks will now pay 61 cents a quarter, up from 57 cents. The new payout implies a yield of about 2.5%, a little better than the 2.4% average yield for dividend-paying stocks in the S&P 500 index.

A high yield doesn't mean much, however, if the business is deteriorating. Starbucks' struggles have been well documented. Pricing, service, and even politics have hit sales growth, leading the coffee chain to look outside for leadership. Former Chipotle Mexican Grill CEO Brian Niccol was named chairman and CEO in August. He started at Starbucks in early September, when the stock was trading for about $77 a share, about 20% lower than it is now.

It can be a little jarring when a new CEO comes in. New management has no incentive to sugarcoat any problems of the past, and there is a tendency to deliver what is unimaginatively called a "kitchen sink" quarter with a lot of bad news delivered all at once.

Recently, new Boeing CEO Kelly Ortberg announced 17,000 layoffs and $5 billion in one-time charges, pushing the airplane maker's third-quarter loss north of $10 a share. Before that, in 2018, General Electric CEO Larry Culp slashed his company's quarterly dividend to a penny per share as he struggled to manage the company's enormous debt load relative to its earnings.

Ortberg and Culp took dramatic action to put their troubled businesses on firmer financial footing. Niccol, and the Starbucks board, decided to raise the company's quarterly dividend amid recent turmoil. It's a sign that despite problems, free cash flow isn't drying up. Wall Street expects Starbucks to generate about $3.5 billion in free cash flow in fiscal year 2025. The new dividend will consume roughly 70% of that amount.

The dividend looks secure, leaving investors to get paid an above-average rate while Niccol works his management magic. He has a track record. Niccol arrived at Chipotle in early 2018. Over his tenure, operating profit margins improved by roughly 10 percentage points, and sales growth dramatically accelerated. Chipotle stock closed in 2017 at about $6 a share, adjusted for splits. Shares now trade for closer to $60.

While Baird analyst David Tarantino called the guidance suspension "disappointing" in a Tuesday report, he still believes Niccol will turn Starbucks' fortunes around. Near-term priorities include "improving staffing levels, simplifying the menu, fixing [pricing], elevating the customer experience, and refining mobile order/pay." Cost cutting is likely on the docket too.

Tarantino rates shares Buy and believes they can reach $110 in a year. "We also see a more bullish scenario for the stock over the next two to three years given the possibility that Niccol's proven playbook can yield outsized U.S. comps momentum and strong EPS power in fiscal year 2026 and beyond," he writes.

Tarantino remains "confident" in Starbucks' potential. The dividend hike is a sign Niccol is confident too. B

Write to Al Root at allen.root@dowjones.com

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October 24, 2024 10:07 ET (14:07 GMT)

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