You Lose if You do Not Consider This Stock

By Federico Flom - September 5, 2012 | Tickers: CBOU, DNKN, GMCR, PEET, SBUX | 0 Comments

• Email
• Print

My criteria for selecting a stock are also my criteria for selecting a business. First, I am looking for a business I can understand—where I think I understand its product, the nature of its competition, and what can go wrong over time. Then, when I find that business, I try to figure out whether its economics—meaning its earnings power over the next five or ten or 15 years—are likely to be good and getting better or poor and getting worse. And I try to evaluate its future income stream. And finally, I try to decide on what I think represents an appropriate price to buy the stock. In the article I analyze Starbucks (NASDAQ: SBUX) and give my opinion on why I like the stock.

Starbucks' level of innovation is fantastic. The company is about to launch the Verismo system, a premium machine which will allow customers to prepare Starbucks-quality espresso and coffee drinks at home, a cup at a time by fall this year. The Verismo system and the expanded partnership with Keurig on the Vue platform are expected to help Starbucks capture further share of this fastest growing market in the coffee industry. The premium single-serve category is expected to become an $8 billion market globally.

In addition, the company opened its first Evolution Fresh juice store in Bellevue, Washington and also launched a new energy drink, Starbucks Refreshers, made from real fruit juice and green coffee extract, in select grocery stores, in March 2012. Evolution Fresh beverages and K-cup packs are available in company operated stores while Starbucks Refreshers are expected to be available in July. In January 2012, the company launched Blonde Roast coffee in the US and Canada in both CPG channels and company stores for consumers who prefer a light coffee roast. Continued innovation and new product offerings would drive both top- and bottom-line growth for the company, going forward. The level of innovation of Starbucks is amazing and these will lead to strength in the company's moat.

Starbucks also recovered very well from the recession. The company's U.S. operations, its largest business, accounted for almost two-thirds of consolidated total net revenues in fiscal 2011. The Americas business has experienced a substantial turnaround since the last couple of years. The $8 billion business has grown well past its previous peak in terms of average unit volumes, store profitability and cash at the store level. The segment regularly posts an operating margin of around 20% which is expected to improve further through new store openings, remodeling of existing stores, new product launches like Blonde
Roast, Verismo, K-Cup, VIA single serve and Evolution Fresh juices over time. The company will keep increasing earnings as management is focused on innovation, new stores and renovations plus focused efficiencies.

I also feel confident on Starbucks international strategy. The Starbucks brand is gaining popularity with consumers across Asia as the company continuously expands its store base outside U.S. Management believes the China Asia-Pacific region will drive much more meaningful business growth over the next five years. Starbucks' business in China is rapidly growing and the region is expected to become the company's second-largest market by 2014. The company is looking to take the store count in this region beyond 1,500 by 2015. Of the 400 stores targeted to be opened in the CAP region in 2012, more than half will
be opened in China alone. Other than that, the company has a nicely profitable business in Japan and hopes to have more than 700 stores in Korea over the next four years. Starbucks is also looking to enter the Vietnam market in September and the lucrative Indian market with a store expected to be opened by the end of calendar 2012. Starbucks is also entering India and expanding its brand with incremental products to sale.

Starbucks has aggressive expansion plans lined up. By the end of fiscal 2012, it plans to add around 500 new stores in the Americas, (primarily in Brazil, Argentina and Mexico), 400 stores in Asia/Pacific, and another 100 in EEMA (East Europe, Middle East and Africa). In the traditional coffee stores, China/Asia Pacific region is the growth driver for the company, registering comparable sales growth of 19% in the first two quarters of the fiscal 2012. Since the company has a low penetration in these regions currently, we expect to see strong comparable sales growth in the short term. Comparable sales for the Americas region grew 8% in the first half of the fiscal, and this is likely to continue in this quarter as well helped by the national roll-out of  Blonde earlier this year.

Thus, I expect the margins for its company-operated stores to remain relatively unchanged since a rise in comparable sales should help offset the increase in input costs. Moreover, the coffee prices have been relatively subdued in 2012 which should also act in the company’s favor.

With a consistent record of positive free cash flow, no meaningful debt maturities until 2017, and leverageable assets on the balance sheet, Starbucks appears to be in sound financial health. Debt/capital is 0.11 (0.60 including operating leases), EBITDA covers interest expense by more than 75 times, and the Cash Flow Cushion (cash on the balance sheet and future cash flow divided by debt and debt-like obligations) is about 4.0 times. In other words, Starbucks has lots of cash to invest in its core business.

I think that Starbucks offer quality growth, a strong moat business and attractive valuation. Starbucks current trailing 12-month earnings multiple is 28x but over the last five years, Starbucks shares have traded in the range of 12.4x to 35.2x trailing 12-month earnings so the stock is in the middle of that range. Based on 2012 earnings estimate of $1.79, the stock is trading at 26.5x a 23% premium to the industry average of 21.6x. On a ROE basis however, the stock looks attractive given a trailing 12-month ROE of 30.9%, which is much above the industry average of 5.6%. If I compare the stock to some of its competitors such as Dunkin Brands (NASDAQ: DNKN) , Peet´s Coffee (NASDAQ: PEET), Green Mountain Coffee Roasters (NASDAQ: GMCR) and Caribou Coffee (NASDAQ: CBOU) I have no doubts that Starbucks is the leader in the industry.

Starbucks trades at a higher P/E and P/S than the rest of its competitors but the company has one of the best management teams in the industry, a great brand, attractive top and bottom line growth potential and stellar operational metrics, which can be seen SBUX nice 30% ROE and 18% ROA.

• Email
• Print
• Feedback