One of the growth stories that has inspired me often is Starbucks (SBUX, Financial). From its beginning in 1971 as a Seattle coffee bean roaster and retailer, Starbucks has expanded rapidly to become the largest coffeehouse company in the world with approximately 23,305 stores in 65 countries and territories. One person who has contributed largely to the phenomenal growth story of the company is Howard Schultz, who acquired the company in 1987. Now, Starbucks is transforming itself from just a coffee place to a comfortable and cozy hangout place that offers a wide spread of food and beverage.
In the third quarter of fiscal 2014, Starbucks reported an increase of 11% y-o-y in revenue to $4.2 billion besides delivering a strong increase of 200 basis points in consolidated operating margin to a stellar 18.5% and a 22% increase in earnings per share to $0.67 per share. Globally, store comps grew 6%, our 18th consecutive quarter of comp store sales gains of 5% or more. Innovation and share expansion also drove strong gains in Starbucks’ premium single-serve packaged coffee and tea portfolios, contributing to a solid 13% increase in channel development revenues. The geographical growth delivered by the company was also nothing short of spectacular.
Over the last two years, its U.S. business has produced revenue growth of over 22%. Our business in China, now approaching 1,300 stores, has never been stronger, contributing to a strong comp growth of 7% in China Asia Pacific. And EMEA demonstrated continued progress against transformation plan, delivering comp growth of 3% with key U.K. market comps outpacing the EMEA regions overall.
Driving innovation
As I mentioned at the beginning, Starbucks has been driving considerable innovation in order to expand into other segments of the beverage business as well as rebranding its image as a full-fledged hangout place. For instance, the company has been making impressive advancement in the tea category with its Teavana brand. In Q3, the company introduced both Teavana Oprah Chai and Teavana Shaken Iced Tea to tremendous customer response. As a testimony to their phenomenal advancement in tea business, just last week, Starbucks opened its fourth new Teavana tea bar on Third Avenue and 63rd Street in Manhattan. These innovations are symbolic of the future vision that the company has for elevating the Teavana brand.
Besides making strides in the beverage business, food is also a crucial area that is taking proper shape in Starbucks’ growth map. Until now food has not been a source of reasonable revenue for the company but after the acquisition of La Boulange, Mr. Schultz said that food has become one of the company's competitive strengths. Given the success of Starbucks and the relative difficulties many restaurants have had in the last quarter, I'm not as bullish about the involvement of food, but Mr. Schultz deserves his due, and we can take his word for the same.
Beware the valuation
Well, there is hardly any doubt about the robust fundamentals of Starbucks’ operations and expansion and brand modification strategy adopted by the CEO Mr. Howard Schultz will definitely bode well for the company. However, the main concern that has been going around in analyst circles is the stretched valuation of the company. The 12 months trailing PE of the company is currently at 251.3 whereas the forward multiple also stands higher compared to the industry at 24.7. As per this Alpha Omega Mathematica compilation, Starbucks has a red flag across most of the valuation ratios.
Shares of Starbucks have been pretty flat over the past year but prior to that experienced an enormous, multi-year rally that saw a nearly continuous uptrend from $10 to $80. After settling into the $70 to $80 range, where we find shares today, the uptrend has clearly been broken. Also, for a hefty valuation at 24x, Starbucks has a low dividend yield of 1.35%. Starbucks is a growth company, which will likely grow earnings per share by 12%-15%/year over the next decade, which somewhat justifies the low yield and optimistic valuation. Yet, the exorbitant valuation is somewhat unjustified and especially because the company is still in the middle of a brand modification exercise, and it will take awhile to show on its income statement.
Takeaway
Starbucks is definitely one of those few companies that can boast of a stellar growth and consistent performance under an extremely capable management team. However, it is overvalued at this point and therefore, it is prudent to wait for a while as the market adjusts to its earnings potential and then make a position in the stock.
