Starbucks: The King of Coffee

Alec is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Why Starbucks

I’m going to start off by saying that I don’t drink coffee a lot, but that really doesn’t matter. There are literally millions of people around the world who drink coffee, most of whom go to Starbucks (NASDAQ: SBUX), Dunkin Donuts (NASDAQ: DNKN), or their Keurig machines made by Green Mountain Coffee Roasters (NASDAQ: GMCR). I personally believe that Starbucks is the biggest player in that industry, because its brand is synonymous with coffee and screams quality. People enjoy going to their stores and, more importantly, people enjoy what they offer.

The Experience is Key

When you walk into a Starbucks, the feeling, the aroma, the great taste and smell, and those nice comfy chairs that always seem to be taken all contribute to the experience. Dunkin Donuts may have good (and cheap) coffee, but the feeling isn’t the same, and they have wooden chairs that aren’t nearly as comfortable. The Keurig machines have a unique experience of being able to make quality coffee at home, but there isn’t anything like the espresso machines and other appliances found in both Starbucks and Dunkin Donuts. You can’t make specialty drinks with a Keurig, and Starbucks’ new Verismo machine is set to directly compete against Green Mountain's Keurig.  

I believe that a person who goes to Dunkin Donuts is there to get cheap coffee on-the-go. Green Mountain's Keurig machine is a perfect replacement for that type of person. But the element that separates Starbucks from the other two is the sit down experience, and Starbucks also offers coffee for people who need to get up and go. Starbucks is the only competitor who is greatly exploring the “sit down and drink coffee comfortably” market.

Starbucks' Moat

Starbucks has several advantages in their moat. First, the brand tells customers that quality is guaranteed, unlike any other walk-n coffee shop where the coffee could be good or bad. Also, customers have an incentive to come back because of the Starbucks Card used to generate rewards such as free refills and free drinks.

In addition, Green Mountain’s Keurig machine is now in shaky territory because of Starbuck’s Verismo machine that does exactly the same thing, if not more. Keurig’s basic models can do just coffee and hot cocoa, and the top model (which isn’t even released yet) can do espresso. Starbucks’ Verismo can do all of that, plus lattes and mochas for the same price.

Furthermore, the advantage Starbucks has is that GMCR doesn’t have stores to sell its products, but instead has to rely on other sellers. Starbucks keeps 100% of the profit from selling its coffee, whereas Green Mountain has to give a cut to the supermarkets and club stores.

Starbuck’s profit margin for 2012 was 10.41%, whereas Green Mountain’s profit margin was 9.42%. Also, Starbucks’ Return on Equity was 29.15% for 2012, and Green Mountain’s was 17.38%. Starbucks makes more because it controls everything from production to sale, and Green Mountain just controls the production part and not distribution to customers.

Additionally, Dunkin Donuts may have good coffee, but they’re not on the same level as Starbucks in terms of making it a good experience. Starbucks has products in place to want people to come back, such as Starbucks iPhone and Android Apps, free Wi-Fi, and the My Starbucks rewards concept of earning stars. Dunkin Donuts doesn’t have that. If I had a business meeting, or asked a friend to get coffee, I would much rather go to a Starbucks than a Dunkin Donuts. The Dunkin brand also doesn’t scream quality like the Starbucks’s brand. I personally think that the same people who go to Dunkin Donuts are also very likely to buy a Keurig or Verismo machines to get their daily fix of energy.

Onto the Numbers

I already mentioned how Starbucks’s profit margins and ROE were higher than Green Mountain’s. As for Dunkin Donuts, sales increased just 4.77% last year compared to Starbucks’ sales increase of 13.67%. EBITDA for Dunkin Brands actually went down 1.68%, whereas Starbucks' EBITDA increased a respectable 14.42% over the last year. All of this means that Starbucks is growing faster than both Dunkin Donuts and Green Mountain. This growth, I believe, is attributed it the experience of going to Starbucks.

Valuing Starbucks Stock Price

  • ROIC growth over the last 5 years is at 20%
  • Equity Growth over the last 5 years is at 17%
  • Sales Growth over the last 5 years is at 7%, but increasing since then
  • Earnings Growth over the last 5 years is at 16%
  • Operating Cash Flow over the last 5 years is at 8%
  • Debt is easily manageable, taking 0.4 years to payback all long term debt
  • Average PE over the last 5 years is at 34

As you can see, Starbucks can still be considered a growth company. Return on invested capital, equity, sales, earnings, and cash flow are all going up at a reasonably good rate. Looking at just these numbers, I would personally give Starbucks a growth rate of 16% for two reasons. First, equity and earnings are both increasing at around 16%, and the big time analysts are projecting earnings of 17.9%, so this is being conservative. Over the last year, sales were up 14%, so if this trend continues, I think 16% overall growth should be attainable.  

Let’s say that Starbucks grows at 16% over the next 5 years. Growing their current income of $1.38 billion at 16%, 5 years from now Starbucks should be making $2.93 billion. Dividing this by the current shares outstanding (749.3 million), you get an EPS of $3.91 5 years from now. Multiplying EPS by a PE of 34 (which is the historic average over the last 5 years), the stock price 5 years from now should be $132.83. Right now, Starbucks is selling for about $56 a share. Very exciting!

When to Sell

Once I get around to buying Starbucks, I plan on holding on to it as long as possible. However, I would sell the company if:

  • They decide to fire the current CEO (and founder), Howard Schultz without a good reason
  • If anything changes to the experience
  • If sales decrease by a lot
  • A new company has great coffee with a better experience at a lower price

So what is my point? Starbucks is a great company with good values and good management. They are expanding all over the world, people love their coffee, and they have a secure competitive advantage. I believe Starbucks has a bright future ahead. Thanks for reading. Please leave a comment below and let me know what you think.

Credit: The method I used to value the company was based on Phil Town’s teachings.


aleceiber has no position in any stocks mentioned. The Motley Fool recommends Green Mountain Coffee Roasters and Starbucks. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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