Stock Analysis - Starbucks (SBUX)
Welcome to the first actual stock analysis on this blog, which will focus on Starbucks stock (ticker SBUX).
As others, SBUX stock has been significantly impacted by the COVID19 outbreak within the past weeks and months. I have nevertheless chosen it as the first company to analyze, even though an accurate outlook might be difficult to make for the time being.
While I am turning to the latest Financial year reports for most of my metrics etc. the forward looking valuations certainly contain a certain degree of wariness to account for possible reductions in fair value.
The below references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.
With that out of the way, here we go:
SBUX - Fundamentals
Market Capitalization: $91.76B
5Y Sales Growth: 10.0%
Current share price: $82.14
P/E Ratio: 29,23 (29,85)
Dividend Yield: 2.0%
Current CEO: Kevin Johnson
Who are they?
Considering the unbelievable number of stores Starbucks (31,256 at the end of 2019) is operating today, most people don’t need to be introduced to it anymore, so I will be keeping it short:
Founded in 1971, the Seattle based company we know as the omnipresent coffee chain, only started forming in the late 1980s after former CEO Howard Schultz took over the specialty coffee stores via his Il Giornale coffee chain company. At that time (1987) Starbucks consisted of less than 20 stores and had just even started to sell Espresso drinks. Schultz rebranded his stores as "Starbucks" and quickly began to expand.
The rest is the history of the fastest growing coffee business over the last 30 years that has now achieved more than $26B in annual revenues and is still expanding into new markets at an incredible pace (to put into perspective the growth from 55 stores at the end of 1989 to 31,256 in 2019; this means that for the last 30 years every 8.5h a new Starbucks store was opened somewhere).
How do they earn money?
Starbucks has structured itself in 3 main segments “Americas”, “International” and “Channel development”, the first two of which refer to company operated and licensed stores selling beverages, food, etc. to customers at Starbucks locations around the world. The latter just includes packaged coffee’s, tea and other products that are being sold outside of branded locations, which currently represent less than 10% of overall revenues.
Americas is by far the biggest and most mature market for Starbucks, with revenues still dwarfing the international segment by a 3:1 margin. However, profits from these very developed territories are now helping further growth in the international segment that could continue also for the years to come.
Overall sales still mostly rely on beverages as the main driver, contributing 60% of all consolidated revenues. Beverages as the core business have come back into focus under new CEO Kevin Johnson, as Starbucks streamlined its’ menu’s while expanding horizontally.
Since it is the first review I am posting, I will link again to the detailed explanation for all the metrics and I will keep the score distribution details in the annex of this entry.
With a final score of 6 within the financial section, SBUX is doing pretty well, outperforming the average of 4-5 points for large cap companies.
EBIT/EV-margin just barely missed the scoring mark and is still quite attractive as debt constitutes less than 25% of overall enterprise value. Cash Flow as a percentage of Sales has a great ratio of 15.2% at the moment and has been increasing rapidly over the past years as well. SBUX started paying a dividend about 10 years ago and has since then consistently increased its' absolute payout over the years.
A 1 point deduction was necessary for a non-existent (negative) Debt/Equity ratio.
Equity is currently still negative as a consequence of growth achieved in the past.
Still, all growth related measures (Cash Flow, Sales and Net Income) continue to show a positive trend and finally add to the total score.
Being well established in what I would call a “mature” market environment (especially in the territories relevant for Starbucks success), SBUX scores 12 out of 15 possible points in our Five-Forces-Analysis (annex).
Naturally with a mature market comes also a considerable amount of Competition for participants within the industry. Superior Brand loyalty, a huge footprint in the main markets as well as the company focus on best-in-class (read “industry”) quality are giving the advantage here to Starbucks and the max score of 3.
Going around the circle in the below graphic, New Entrants make up the next category. With entrance barriers to the higher quality coffee shop businesses not being too high (price for coffee beans has a low volatility and capital required for a single shop is negligible), the risk of new entrants is always in the background for all existing companies. While in the recent years smaller businesses and chains have taken an increased market share from the bigger companies in the coffee niche (i.e. Starbucks, Dunkin Donuts, McDonalds), overall market growth especially for specialty coffees still outpaces that dynamic. With their superior capital possibilities, Starbucks as others might also be better equipped to weather through a significant market drawback as we are seeing at the moment. 2 points scored with a tendency towards 3.
With a cup of coffee effectively holding the status of an “everyday item”, Customers could be considered to have reasonably high price sensitivity and might react adversely if their favorite Espresso beverage becomes more expensive. Still, I am giving a score of 3 in this category. Starbucks’ focus on the higher-end of products, where customers are anyway willing to pay slightly (or much) more for superior quality, should give them an advantage also in terms of pricing power. Their superior brand itself, Brand loyalty of their customers and top-class rewards program create additional incentives to keep coming back.
Despite (or because of) being dedicated to 100% ethical and sustainable sourcing of their raw material, I am also giving 2 points in the Supplier section. Notwithstanding a few controversies (ethiopia link), having reached the 99% mark of that goal in 2015 was a big step forward not only for Starbucks, but also for the industry as a whole which has a long history of exploiting farmers for the profit of big coffee companies. While this might lead to higher purchasing prices than those of some of the competitors’, it should benefit not only the farmers but also Starbucks itself greatly over the longer term. Sustainable and ethical sourcing is the trend not only for the coffee- but also many other industries. That being said, still a big portion of overall supply is sourced from Latin America and therefore could be impacted by possible geopolitical or macro economical events. Starbucks is trying to mitigate these issues by bigger diversification while still keeping their 100% goal in mind (as difficult as it may seem to reach), which is why I am awarding 2 points.
Finishing up the Five-Forces Analysis is the Substitutes category. As long as people just crave a cold drink, flavored beverage or caffeine kick, there are several eligible alternatives. Recent worldwide trends in the direction of a more healthier diet have of course non passed over the coffee shop and restaurant industry, whenever customers opt for a plain water instead of a sweetened drink. On the other hand this can be seen as an opportunity to also influence demand in the direction of higher priced (plain) coffee alternatives, so I am giving a “neutral” 2 point rating.
As I made up the items of this category to use in the assessment of each and any company I will analyze here, I will not always follow the definition to 100% accuracy. E.g. it is of lower importance for a 3rd tier b2b company to have a strong brand.
Starbucks and its’ business are not something that benefit from the Network Effect “as per definition” (link). Rather, by bringing the concept of coming together over a cup of coffee (or your favorite Espresso beverage) into your local community or getting your fix before work, they have effectively created the habits in the people, they needed in order to succeed. “Let’s have a coffee together” – “sure I’m already at Starbucks, why don’t you come?” – Full marks (5).
When building up a brand identity, few companies can match what Starbucks has accomplished in terms of amassing a huge and loyal following of returning customers, keeping them around for a long time via rewards incentives and fitting into the lifestyle of so many not only millennials, but also the following generations. It should therefore come as no surprise that Starbucks is one of the 50 strongest (and still growing) Brands in the world. 5 points also in this category.
When talking about Scalability or Exponentiality I am referring to the chances of achieving not only cost saving effects from having a bigger scale but also the opportunity of increasing sales much more than possible through traditional channels. In terms of physical scalability there are of course some limits to a business like Starbucks’ that still heavily relies on physical locations in many places (and even draws its’ appeal from this). On the other hand, the possibility to utilize its’ growing mobile ordering system to facilitate an increased amount of orders in a shorter time provides Starbucks with another option to significantly “scale up”, especially in more densely populated areas. Therefore I am awarding 3 points in this section.
Final attractiveness rating: 78%
With a total score of 31 out of 40 possible points, SBUX stocks achieves a rating that is above average in many ways, signaling that fundamentally the company is
- Quite safe financially and business-wise (6/10)
- Well positioned inside its’ own industry (12/15)
- Profiting from other effects like a strong brand and reasonable options of scalability (13/15)
That being said, of course the current impact from the Coronavirus may still need some time to become fully evaluated! It might therefore of course have some profound impact (at least in the short- to mid-term) especially on the financial rating.
Taking all of that into account let’s look at a possible current valuation.
Intrinsic Value Calculation
Company valuation via Discounted Cash Flow Model
There should be no doubt that the outbreak of the Coronavirus around the world has deeply impacted more or less all business at least in some way. Besides the travel industry, Cafés, Restaurants and bars have been among those hardest hit. Be it through forced store closures or significantly decreased customer visits, the long term effects of the pandemic are yet to be uncovered in many areas.
In its’ 2nd quarter earnings call end of April, management already guided to a decreased revenue between 15% and 25% for their international segment, based on their experience within China. At that time more than 50% of global company owned as well as licensed stores were closed or running on a drive-through only model.
Notwithstanding possible long-term impacts I have considered a similar assumption also to be valid for the complete Americas segment (-30% revenues), when estimating possible future cash flows. While an increased revenue from the Channel Development segment seems more than realistic, we saw earlier that it is a rather small portion of the overall sales und will therefore have little impact.
It should therefore come as no surprise that I expect this fiscal years cash flow to be significantly lower than what was achieved in 2019. Going forward I am expecting some further mid-term impact in the following fiscal year 2021 (e.g. through lower revenues from slightly lower on-site customer levels or additionally needed investments to adapt new in-store concepts in the wake of COVID19).
With a lot of the market recovery depending on how well people will adapt to social distancing rules etc. my expectation for a realistic return to previous Cash Flow levels and/or further growth would be around the fiscal year ending in 2022.
This development leads to a series of Cash Flows and an Equity Value calculation as follows and an estimated Equity Value of 113.7 $billion:
Company Valuation via Multiple
Trying to be straight forward and a little bit shorter in this section I have chosen the following 3 companies as a peer-group, even though they partly (or even mostly) operate a completely different business. Namely these are:
- Coca Cola
- Dunkin Donuts
Nevertheless all of them also have a distinct relation to the coffee business. Coca Cola through its acquisition of Costa Coffee, McDonalds and Dunkin Donuts from selling (rather lower priced) coffee at their locations, but are both serious competitors through their more than competitive footprint especially in the Americas region.
Chinese coffee chain Luckin Coffee, which had already been marked as the “Starbucks killer” after its’ IPO in the US in early 2019 is intentionally left out of the peer group due to the currently ongoing fraud investigations. Even before they were operating at a loss of 1$ per cup of coffee and sales multiple was extremely high, so that it might have unrealistically skewed the valuation quite a lot.
That being said, here are the Earnings (83.4 $billion) as well as Sales Multiple (147.9 $billion) Equity Value calculations:
What is clearly visible is the significantly lower value coming from the Earnings Multiple calculation, which could be a sign for either a slight overvaluation compared to its’ peer companies and/or might indicate that the market expects future growth of Starbucks earnings to be higher than that of the competitors.
If we now take a look at all calculations here’s what we came up with:
With the Discounted Cash Flow result being “somewhere in the middle” between Sales and Earnings multiples, our average equity value also tends in this direction, ending up at an estimation of roughly 115 billion$ (98.3$ per share)
Compared to the current Market Cap of ~96 billion$, this indicates a potential upside of 19.6%.
Whether the scenario plays out in the forecasted way remains of course to be seen.
Always being optimistic and hoping for the best, while expecting the worst I see (among others) the following factors that could further impact future Cash Flows beyond my above forecasts.
What are you’re thoughts on Starbucks stock and business?
Let me know in the comments if you feel I am completely wrong (or completely right! ;-))
From today I will also be taking requests on which company to analyze in the future!
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Thanks and until then!
I am invested long in Starbucks.
1) EBIT/Enterprise Value ratio (1 point if >5%; 0 points if between 1%-5%; -1 point if <1%):
2) Enterprise Value/Market Cap (1 point if <1,5; 0 points between 1,5-2 ; -1 point if >2):
3) Cash Flow/Sales ratio (1 point if >5%; 0 points between 5%-1%; -1 point if <1%):
4) Debt/Equity ratio (1 point if <1; 0 points if between 1-2; -1 point if >2):
5) Operative Margin (1 point if >20%; 0 points if between 10%-20%; -1 point if <10%):
6) Dividend Yield (1 point if >2%; 0 points if between 0%-2%; -1 point if 0%):
7) Operative Cash Flow 5y CAGR (1 point if >10%; 0 points if between 1%-10%; -1 point if <1%):
8) Sales 5y CAGR (1 point if >10%; 0 points between 0%-10%; -1 point if <0%):
9) EPS 5y CAGR (1 point if >10%; 0 points between 0%-10%; -1 point if <0%):
10) Effectiveness (1 point if 9) > 10; otherwise 0 points):