Starbucks: Still the Premium Beverage King
Steven is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Third-quarter results are in and it’s clear Starbucks (NASDAQ: SBUX) isn’t going to get much love from shareholders right now. That’s because we are a difficult bunch to please and often like demanding unrealistic things – sometimes just for the fun of it. We don’t take kindly to bad surprises and will punish those who dare go there. What we think is bad is totally up to our mood because we are a product of our environment. If Europe has us down, NO-SOUP-FOR-YOU! It doesn’t matter that business is humming along swimmingly and the long-term trajectory is intact. Missed by a couple of cents? How would you like a 10% haircut with your tall-skinny-mocha-three-Splenda-late?
Is this seemingly shortsighted reaction the Grande opportunity of a lifetime?
Not So Venti?
Analysts still believe Starbucks will grow earnings over 19% per annum, for the next five years. This growth rate makes shares worth about $40 – fundamentally speaking. It’s low because Starbucks is currently trading a relatively high PE multiple of 26. Even if I add last year’s cash flow per share to the valuation, it only adds another $2.30.
A fundamental view doesn’t typically tell the whole story. A PE of 26 is on the low side when you look back over the last 10 years. The extremes ranged from about 18 (mid-2008) to over 120 (mid-2009). Since the Great Recession of 2008, in the last two years, Starbucks’ PE has ranged from about 21 to 35. During this shorter timeframe, shares have appreciated almost 90%, outpacing the S&P 500’s return by over 65%. If a PE of 20 is the lower end of the range during calmer markets, it stands to reason shares are likely near a bottom in valuation. This reasoning, of course, hinges on Starbucks’ ability to keep growing.
Here’s a quick breakdown of how business fared during the third quarter versus the year prior:
- Revenues up 13%; EPS increased 19%; Operating income up 21%;
- US comparable store sales up 7%; Global comparable store sales up 6%.
- Channel development revenues up 45%.
Other key highlights include:
- Opened 231 net new stores, including its 600th store in China.
- Opened their first stores in Finland and Costa Rica
- The premium coffee segment accounts for more than 50% of the total coffee sold in US grocery stores.
- Starbucks K-Cup command 22% of the market.
- Expected to open 1,200 net new stores in fiscal 2013.
Everything here looks great. Business is growing, management is expanding operations, and Starbucks is a dominant player in the caffeinated world. The only issue I’ve uncovered is that they experienced gross margin declines of 130 basis points, citing rising coffee costs. On the brighter side, margins are expected to improve by 50-100 basis points by the year end. Margins are certainly worth keeping an eye on in a business that’s sensitive to input costs.
It’s safe to say the coffee biz is crowded. That’s not surprising when you consider that 100 million Americans get their fix daily. And that’s just America. Worldwide there are over one billion coffee drinkers up for grabs. McDonald’s (NYSE: MCD) is the prime example of putting a target on Starbucks’ back. McCafe is their way of saying they can do the Starbucks thing while still offering the value you’d expect from the golden arches. This premium branding approach with super-sized value has proven successful, having increased foot traffic in between mealtimes. Where McDonald’s has the edge, is their footprint – it’s double the size. It makes Starbucks look like David, engulfed within the shadow of Goliath. If they were car companies, Starbucks would be BMW, where McDonald’s would be General Motors. Which do you think would understand their identity better in the premium beverage world?
Dunkin Brands (NASDAQ: DNKN) has only been public for one year, but has been serving coffee for over 60. East-coasters will get in-your-face about Dunkin’ being the best – end of story. These outspoken coffee drinkers are overlooking Dunkin’s relatively small footprint in comparison. There are only 2,600 stores worldwide – there simply isn’t enough Dunkin’ to go around. What Dunkin’ sold in the last five years is less than what Starbucks sold last quarter. They probably aren’t the threat Starbucks is most concerned with.
Green Mountain Coffee Roasters (NASDAQ: GMCR) has certainly had their host of issues that shareholders haven’t taken lightly. It’s why shares are down 82% since last year. Trust issues aside, they own the Kuerig brand and the infamous single serve K-Cup. Back in March of last year, Green Mountain entered an agreement, where Starbucks can produce K-Cups in exchange for selling the machines in their stores. I mentioned earlier how Starbucks has made inroads here, and now commands 22% of that market. That’s an impressive amount of growth in less than two years.
Other competitors include Peet’s Coffee & Tea (NASDAQ: PEET) and Caribou Coffee Co., but both of these premium brands are just that – premium and niche like. While Starbucks can certainly learn from their practices, they likely wouldn’t feel threatened from them. They don’t earn enough revenues, nor have the footprint to directly threaten Starbucks’s business model.
The competition may be stiff, but Starbucks is no rookie stepping into the batter’s box. And shares come primed with exciting new catalysts. The integration of La Boulange and Evolution Fresh are ways they are building on and improving the customer experience. Couple this with more expansion and future alcohol offerings, you get the Starbucks of tomorrow. These initiatives will further differentiate themselves as the premium beverage king. It’s no longer just about a caffeine fix and a green mermaid – I don’t suppose it ever was.
TopDownTrends has no positions in the stocks mentioned above. The Motley Fool owns shares of McDonald's and Starbucks and has the following options: long DEC 2012 $16.00 puts on Green Mountain Coffee Roasters and short DEC 2012 $21.00 calls on Green Mountain Coffee Roasters. Motley Fool newsletter services recommend Green Mountain Coffee Roasters, 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.