Is Starbucks a Good Investment?
Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
We place a strong buy on Starbucks Corporation (NASDAQ: SBUX) stock on the back of its state-of-the-art product portfolio, diversity and superiority of its coffee products combined with resilient consumer demand and its future expansion plans in other markets. The company is one of the leading roaster, marketer and retailer of specialty coffee in the world through company operated stores, licensed stores, and through other retail channels. Owing to continuous investment on improved operational foundation, invigorated innovative muscle, the revenue base of the company depicted an increase of 11%, amounting to USD 11.7b in FY11. The revenues generated from Consumer Product Group (CPG) food service and licensed-stores showed immense growth of 22% and 15% respectively, while company-operated stores registered nominal growth of 7%.
Key Thesis Points
1. SBUX holds a significant position in the global food sector and is the world’s largest coffeehouse company in the world, with more than 20,000 stores worldwide. The company holds a dominant position in the "Coffee & Snack shops” in its US with a market share of 32.6%, followed by its main competitor Dunkin Brand (NASDAQ: DNKN) with a share of 16.1%. Going forward, we expect strong competition in the restaurant segment from McDonald’s (NYSE: MCD) as they are shifting their focus from hamburgers to Freshly-brewed coffee. But keeping in mind Starbucks’s traditional Coffee experience and continued diversity in its products, we believe they are well positioned to cope with the stringent competition. The competition in restaurant segment is more stringent, where MCD holds dominant position, while SBUX is striving hard to grasp market share from MCD.
2. During FY12, Starbucks witnessed a substantial growth in its bottom line which was mainly driven by its expansion strategy that includes the company’s loyalty program, innovative products and new food & beverage options. During FY11, the business generated from the US market continued to expand with a modest growth of 6% in the revenue base and contributed 69% to total revenues. Moreover, the revenue generated from the international operations grew substantially by 15%, which mainly pertains to company operated stores during FY11. Going forward, we anticipate expansion in new markets which will provide the company with new revenue sources. In FY11, sale of beverages account for a whopping 75% while the company intends to shift its focus on food, whole bean and soluble coffees because it can provide them foundations to compete with giants like MCD and Dunkin Brand. In 1Q12, the company directly marketed and supplied SBUX products to retail/convenience stores, which has lead to a substantial sales growth of 57%.
3. Despite robust growth in sales and rising cost of sales, the gross margins of the company remained at the prior year level of 58% against the industry average of 24%. While during FY11, the operating expenses increased by 5% which were in line with inflationary pressures. On the back of substantial expansion in revenue base, the company was able to increase its operating margin from 13% in FY10 to 14.5% in FY11. Accordingly, the company's net income increased by 32% to $1.25b against $945m in FY10. Resultantly, the net margin of the company improved to 10.6% against the industry norm of 10.3%. Moreover, the ROA & ROE improved to 16.9% and 28.4% against 14.8% and 25.7% in FY10, respectively.
The equity of the company stood slightly higher at $4.4b. The increase was mainly attributable to the increased reinvested earnings. Meanwhile, the total borrowing of the company remained at the prior year level of $549m. Accordingly on the back of a substantial improvement in company’s bottom line, the leverage of the company improved to 0.13x against 0.15x in FY10. The operating cash flows stood at $1.6b in FY11 representing ample cushion to support the continuous expansion in other parts of the world.
4. As a retailer that is dependent upon consumer discretionary spending, SBUX’s results of operations are sensitive to changes in macro-economic conditions. Its major source of revenue is the US market which, if at any time, faces financial/economic pressures could pressurize earnings. Moreover the company is exposed to several risks including; foreign currency fluctuations, macro-economic conditions of foreign markets, and penetrating competitive environment.
Brief Valuation
Starbucks Corporation is a growth stock with a price to book ratio of 6.33x against the industry norm of 0.7x. During FY11, the P/E ratio of the stock has experienced an increase and stood at 21.5x against 21.4x in FY10. While analyzing the historical share price trend, we believe that the stock is slightly undervalued and will demonstrate a recovery in price going forward. The estimated beta of the stock is 1.23, which signifies higher sensitivity to the movement of the stock market. Going forward, based on strong fundamentals originating from a diversified product portfolio, its presence around the globe, stringent market position, substantial cash flows, and expected PE multiplier, we value SBUX at $65.00.
This article is written by Nawazish Mirza and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool owns shares of Starbucks. Motley Fool newsletter services recommend McDonald's and 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.If you have questions about this post or the Fool’s blog network, click here for information.
