Sit Back & Watch This Giant Go Up

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

The world’s most cherished coffee giant, Starbucks (NASDAQ: SBUX), has not only outshone its rivals in the last couple of years, but its share price has also moved in tandem with its success. A stock that yields a year-to-date capital appreciation of more than 32% is by no means an ordinary stock. Having said that, the million dollar question is, will Starbucks continue to mint substantial income in the future as well?

Recent Developments

Introduction of handcrafted soft drinks

Starbucks has plans of expanding itself in a number of non-coffee items such as juices, teas, energy drinks and pastries. As part of this plan, Starbucks has recently tested a series of handcrafted soft drinks in Austin and Atlanta, which includes root beer, ginger and lemon ale. According to Starbucks' spokeswoman Lisa Passe, “We test products to help us understand how new product extensions can fit within our customers’ daily routine – throughout the day.” If the tests do well, these new soft drinks may be launched across the U.S.

Price increase in U.S.

Last month, Starbucks announced that it would be increasing the price of some of its beverages by 10 cents, starting June 25. This would only be done in the U.S. company-operated cafes. According to Starbucks’ spokesperson Lisa Passe, this is the first price increase in more than two years. She further said, “Less than a third of beverages will be affected by the price increases. In most stores, the price of a Grande or Venti brewed coffee, as well as Frappuccino and Refreshers, will remain the same.” The average price would increase by 1% in the U.S., Passe said.

Starbucks did really well in the U.S. last year, where it made more than $10.5 billion in revenue. Therefore, this news comes as a surprise to a lot of customers. According to some analysts, with coffee bean prices going down, prices should have been curtailed rather than being escalated. As a result, Starbucks’ loyal customers would face a stern test. The big question is, will this price hike hurt Starbucks or will it bring more revenue for the company going forward?

Smaller loss in U.K.

Helped by a 4% increase in revenue, Starbucks reported a loss of 30 million pounds in the UK, down from a loss of 32 million pounds, last year. However, Starbucks’ books were undercut by a royalty worth 26 million pounds in the Netherlands. It also paid an interest of 2 million pounds to affiliated companies. Still, the company managed to reduce its operating loss in the United Kingdom, showing a lot of resilience during an economic downturn. 

Valuation

Starbucks is trading at a high forward P/E of 26.51 amid high expectations from the investors. It has a PEG of 1.68 and a PEGY of 1.59. Using earnings multiples, I would value Starbucks. Using an industry forward P/E of 23.5, I can value Starbucks. But, as Starbucks is expected to outperform its competitors in the coming years, I would value it using a premium of 20%.

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According to 2014’s high estimates, Starbucks’ value comes out to be $77. This shows that it’s an undervalued stock and has an upside potential of almost 11%. Adding its dividend gives us a total yield of more than 12%.

U.S. coffee industry

Based in Vermont, Green Mountain Coffee Roasters (NASDAQ: GMCR), specializes in specialty and organic coffees. Two months ago, Starbucks and Green Mountain Coffee Roasters extended their partnership to a minimum of five years, which would allow Starbucks to increase the number of products that can be used on Green Mountain’s Keurig brewers. The deal is expected to benefit both the companies to a great extent. 

After doing a great job with Starbucks, the company has further plans of expanding itself in the food service sector. In the second quarter, Green Mountain toppled its earnings estimates by $0.20 and posted an EPS of $0.93. Green Mountain is trading at a forward P/E of 19.03 and has a PEG of 1.04, making it a slightly cheaper buy in the coffee industry. A mean recommendation of 2 on the sell side shows that it’s also among the best buys in the coffee industry.

Thanks to a staggering coffee margin of 95%, the American doughnut giant, Dunkin Donuts (NASDAQ: DNKN), has decided to shift its primary focus on the coffee market. Recently, company’s CFO, Paul Carbone, said that the company is now a beverage company rather than just a doughnut company. Last year, Dunkin’s core beverage products accounted for more than 58% of its U.S. sales. Dunkin Donuts has a forward P/E of 24.3 and a dividend yield of 1.70%. It has a PEG of 1.84 and a PEGY of 1.72. According to the sell side, it has a mean recommendation of 2.2, showing that it’s a good buy but not as good as Starbucks and Green Mountain Coffee Roasters.

Conclusion

Starbucks’ earnings in the U.K. suggest that the company is finally heading towards the right direction. In 2012, sluggish economic growth was the reason behind the company’s dull performance in the region. In 2013, things look much better, whereas in 2014, the company is expected to report positive income in the U.K.

Starbucks’ plans of expanding itself in the non-coffee market would certainly help the company in growing its revenue beyond the coffee market. Given the fact that U.S. customers’ personal disposable income is increasing, Starbucks’ price hike won’t hurt its sales. In fact, this price raise would work in company’s favor by bringing in more revenue. Moreover, with the U.S. economy improving at a gradual pace, Starbucks’ future looks much brighter.

Starbucks’ has yielded more than 300% to its investors during the last five years, making it one of the top stocks in the market. Starbucks will continue to do wonders in the coming years as well, making it a great buy, especially for the long run. In short, buy Starbucks for an upside of 11%.

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Waqar Saif 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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