Starbucks (SBUX, Financial) has been a stock that has delivered sustained value to shareholders in the past. I see shareholder value creation as continuing in the coming years as well. As the stock has corrected 13% from year to date highs, this article discusses the reasons to be bullish on Starbucks and use the current correction to accumulate the stock.
Coming to the first factor to be bullish on Starbucks, when the company reported third quarter results, the comparable restaurant sales increased 7% in China, 4% in the United States and 4% globally. The robust growth in China’s comparable restaurant sales is noteworthy and this is the first long-term upside trigger for Starbucks.
To elaborate further, net revenues for the China/Asia Pacific segment grew 18% in the third quarter as compared to the same quarter last year, and the increase was primarily driven by incremental revenues from 888 net new store openings over the past 12 months.
I am focusing on China’s growth because it was recently reported that Starbucks plans to double the number of restaurants in China to 5,000 by 2021. With strong revenue growth and comparable restaurant sales growth an indication of increasing acceptance of Starbucks in Asia’s largest economy, the company is moving in the right direction and I see China becoming the second biggest market (after the U.S.) in the next 5-10 years.
Importantly, strong growth in China will ensure that steady revenue growth sustains for Starbucks in the coming years even if growth in the United States and other developed markets is relatively muted.
I want to add here that Starbucks also plans to increase roasting capacity in India, which is still a very small market for the company. However, China is home to 1.3 billion people and India is home to 1.2 billion people. In the next 5-10 years, I see Starbucks expanding aggressively in India. Starbucks has already mentioned that India will be among the top five markets in the long term. It is clear that the company’s strategy is to increasingly focus on new markets where high growth can help sustain the company’s overall revenue and earnings per share (EPS) momentum.
From a financial perspective, there are minimal concerns with the company having a strong balance sheet and robust cash flows. For the first nine months of 2016, Starbucks reported operating cash flow of $3.3 billion as compared to $2.8 billion for the same period of 2015. The reason for mentioning this is that Starbucks used nearly $2.5 billion during the same period on dividends and share repurchases. With the cash flows covering for shareholder value creation, I see dividends as sustainable and I also expect continued value creation through share repurchase.
From a valuation perspective, the annualized EPS for fiscal 2016 comes to $1.8 per share and this translates into a price-earnings of 29, considering the current stock price of $53.2. I don’t see valuations stretched considering the fact that Starbucks recorded EPS (GAAP) growth of 24% in the third quarter of 2016 as compared to 2015. If strong EPS growth sustains, forward valuations will remain attractive. Further, Starbucks does deserve premium valuation considering steady dividends, continued share repurchase and strong long-term growth outlook from emerging markets.
Considering the risk factors, I see geo-political worries as a concern for the long term. The relations between the United States and China have been strained in the recent past and strained relations can potentially impact businesses. However, I see the probability of this risk playing out as minimal. Also, competition from local players in emerging markets is a risk, but the comparable store sales growth numbers for Starbucks indicate that brand-pull is strong.
In conclusion, Starbucks is worth considering in the current correction for medium to long term and I expect the company to report strong growth in the long term, driven by focus on emerging markets. Sustained dividends add to the attractiveness of the investment along with EPS boost through regular share repurchases.
Disclosure: No positions in the stock.
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