SBUX is rated neutral; valuation is too high (forward P/E 30, price 93 vs DCF fair value 66) despite positive view on CEO strategy.

We have interesting news for Starbucks stock investors, as the company has announced the closure of an additional 250 stores. And of course, if you've been following my coverage of Starbucks, I've been emphasizing that this is a likely scenario .

I feel that Starbucks suffers from what I, and many economists, call "economies of scale," where its size leads to inefficiency. This happens when a business, or one of its sectors, grows so large that it becomes difficult to manage effectively, and costs begin to rise at a faster rate than sales growth.

So, when that happens, it usually makes sense for a company to downsize and remove some parts that do not contribute to overall profitability or overall competitive advantage .

Let's take a look at these details, and why I think there's more to come. In a message posted on the Starbucks blog and sent to employees on Thursday, Chief Operating Officer Mike Grams revealed plans to close 250 stores in the United States and Canada this week.

I think the problem is more acute in North America, especially in the United States . Starbucks has a wide reach, with a branch on every street corner, and possibly more than one branch on every street corner depending on where you live.

Therefore, 250 stores represent less than 1% of their total number of stores in the United States and Canada.

In total, they have more than 40,000 branches worldwide. Therefore, this number is small compared to the general situation. That's why I believe there's more to come .

They've done two rounds of store closures so far , and I think more are needed. I think Starbucks has grown to a size that is difficult to manage.

All credit to Brian Nicol, CEO of Starbucks. He was a great CEO at Chipotle, and he's had an excellent start so far with Starbucks.

I agree with the strategy of starting to downsize. This demonstrates the effectiveness of CEO Brian Nicol, who identified this problem as one of the issues that needed correcting.

So, here's more evidence that suggests the excessive size of this economy is causing problems.

You can see this in the operating profit margin , which has decreased significantly since 2017 when it was 18%. It's at 10% now, isn't it?

As a company grows in size , sales grow, but operating profit margins shrink. This is usually evidence that costs are increasing at a faster rate than revenues. Starbucks' cost equation has changed significantly.

Labor costs have increased significantly over the past decade. There is a shortage of frontline workers , that is, people who work in person at these locations. The difficulty of finding enough skilled workers to work in Starbucks branches is not limited to Starbucks alone.

Not only that, but wages have also increased significantly. Minimum wage laws have been passed in several US states, notably in California, where restaurant workers are now required to earn more than $20 an hour as a minimum wage.

These are new things that Starbucks did not expect to rise so quickly, especially in light of the unprecedented circumstances of the coronavirus pandemic. These factors have radically changed the equation for Starbucks, resulting in a situation where the costs are extremely high compared to the expected benefits of opening additional branches.

We can also see this in the company's return on invested capital, which was excellent before the pandemic. The returns on invested capital exceeded 30% for several years.

Then came the pandemic and the subsequent volatility, and now the return on invested capital is approaching its lowest level at only 11.5%. It barely covers the company's weighted average cost of capital.

Therefore, these additional capital investments in adding new sites do not generate enough return to offset the cost of capital. Therefore, I believe there is an increasing need for Starbucks to reduce the number of its locations,

Therefore, I expect Starbucks in North America, specifically in the United States , to continue closing stores and giving up part of its market share, because there is no point in Starbucks holding onto this share if it will lead to a decrease in the company's profits.

In the short term, this may improve Starbucks' profitability, but in the long term, it could lead to the emergence of a strong new competitor, Dutch Bros., or other competitors if Starbucks is not careful and gives up too much in the process of restructuring its business.

She is really in a difficult situation. The good news is that it has a very competent CEO to handle this situation. However, it remains difficult. I don't envy him his position.

Starbucks shares are currently trading at a forward price-to-earnings ratio of 30, which I consider high. I think this price is excessive for a company in this situation, but it enjoys this level of trust thanks to Brian Nicol.

If you didn't know , Brian Nicol did such an excellent job at Starbucks, I mean at Chipotle, that investors are so confident in his ability to turn Starbucks around.

They already take some of these benefits into account when pricing their shares. Therefore, I don't like the stock's valuation at these levels under these circumstances. Similarly, I calculated the fair value of Starbucks using a discounted cash flow (DCF) model at 66. The current market price is 93.

Starbucks is a great brand and I would certainly like to add it to my portfolio, but not at these levels. I would prefer to see a much better entry point for Starbucks before buying and before raising my buy recommendation.

Therefore, I had rated this stock as "neutral," and I will reaffirm that rating today.