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Mark Yu
Mark Yu
Articles (232)  | Author's Website |

Starbucks Nearing Its 1-Year Low

The growing coffee business

October 21, 2016 | About:

Starbucks (NASDAQ:SBUX) declared on Wednesday that it is on track to achieving 5,000 stores in China. The $78 billion coffee company plans to double the number of its stores in the country.

As of June 26, Starbucks had 24,395 stores globally, a 5.87% growth from fiscal 2015. In the same period, Starbucks had more than half (62.7%) of its stores, either company operated or licensed, in the Americas (1). Meanwhile, Starbucks had a quarter of its total stores, or 6,127, in China and Asia Pacific.

Earnings performance

On July 21, Starbucks delivered its third-quarter earnings report. The world-renowned coffee company delivered 9.5% growth in its top line to $15.6 billion compared to the previous three quarters last year. However, Starbucks delivered -4.2% growth in its profit to $2.02 billion in the same period.

Also, third-quarter consolidated comparable sales was up 4% (2). Starbucks closed up 0.52% the following day with the broader market, Standard & Poor's 500, ending up 0.46%.

As observed, Starbucks had more operating expenses for the period with 9.2% growth accompanied by another 7.4% increase in taxes, which led to lower profits for the period.

“Starbucks' record Q3 performance, highlighted by strong 7% comp growth and record revenues and profits in China and 18% year-over-year growth in our Starbucks Rewards loyalty program, demonstrates the strength and resilience of the Starbucks brand and business around the world.

“As we enter Q4 and approach fiscal 2017, we have clear line of sight to returning our U.S. business to historic levels of comp sales growth which had been at or above 5% for the 25 consecutive quarters prior to Q3.” – Howard Schultz, Starbucks chairman and chief executive officer

(Starbucks, annual filing)

Starbucks

Starbucks was formed in 1985 and currently is the premiere roaster, marketer and retailer of specialty coffee in the world, operating in 68 countries (4).

Starbucks purchases and roasts high-quality coffees that it sells along with handcrafted coffee, tea and other beverages and a variety of fresh food items, including snack offerings, through company-operated stores.

Starbucks also sells a variety of coffee and tea products and license its trademarks through other channels such as licensed stores, grocery and foodservice accounts.

Starbucks, along with its flagship brand Starbucks Coffee brand, also conducts its business with the brand names Teavana, Tazo, Seattle’s Best Coffee, Evolution Fresh, La Boulange and Ethos.

Starbucks also conducts its business through stored value cards that are related to the My Starbucks Rewards® loyalty program, which can also be accessed via the Starbucks® mobile app. According to the company, its customers may access their card balances by utilizing their stored value cards or the Starbucks® mobile app in participating stores (8).

Starbucks’ Channel Development includes roasted whole bean and ground coffees, premium Tazo® teas, Starbucks- and Tazo-branded single-serve products, Frappuccino®, Starbucks Doubleshot® and Starbucks Refreshers® beverages. These products are sold through different channels and retail stores.

(Global Company-Operated and Licensed Stores, annual giling)

As observed, Starbucks has operated most of its stores in the Americas while letting the licensees take over in most of the Starbucks stores located in CAP and EMEA. In review, Starbucks acquired Starbucks Japan stores with its 1,009 count for $900 million in the first quarter of 2015.

Starbucks' company-operated stores contributed 79% of total sales while the licensed stores contributed 10% of sales in fiscal 2015.

Meanwhile, Starbucks beverages contributed most, 58% or $11.1 billion, to its total sales in fiscal 2015. Food, Packaged and single-serve coffees and teas and other contributed 16%, 14% and 12% (7).

The coffee company has four reportable operating segments: 1) Americas; 2) China/Asia Pacific (CAP); 3) Europe, Middle East and Africa (EMEA) and 4) Channel Development (5).

In fiscal 2015, Americas contributed 69% to total Starbucks sales, CAP had 13%, EMEA had 6%, Channel Development had 9% and All Other Segments had 3%. Starbucks’ Americas business is the most mature business among the group while its CAP and EMEA are still in the early stages of business development, resulting in higher gross expenses but with higher operating margins (6).

As per segment sales growth, CAP leads the group with 112% growth in fiscal 2015 followed by Channel Development with 20%, Americas 11%, and All Other Segments 5.8%. EMEA delivered -6% sales growth year on year.

As per operating margin, Starbucks' most profitable segment was its Channel Development with 37.8% margin followed by Americas 24.2%, CAP 20.9%, EMEA 13.8% while All Other Segments delivered -4.7% margin.

Meanwhile, three quarters into fiscal 2016, Starbucks grew most of its sales in CAP business operations with 20.4%. The company also grew its Americas business by 9.3%. On the other hand, Starbucks experienced -5.9% sales growth in Europe, Middle East and Africa (EMEA).

For the past five years, Starbucks grew its sales on average by 12.35% and profits by 23.87%.

Comparable sales

(Starbucks Comparable Sales, Annual and Quarterly Filings)

As observed, Starbucks' comparable sales had been on an observable decline over the recent three quarters. Quarter-on-quarter comparison revealed that Starbucks’ consolidated comparable store sales was lower by 42.9% than third-quarter 2015, brought down mostly by its EMEA’s -1% performance.

Cash, debt and book value

As of Starbucks' latest quarter, the company had $2.3 billion in cash and $3.6 billion with a debt-equity ratio of 0.63 (3). The company had 16%, or $2.2 billion, in goodwill and intangibles with its $13.8 billion assets and a book value of $5.72 billion.

Cash flow

(Starbucks Cash Flow, annual filing)

Starbucks’ fiscal 2015 cash flow from operations grew by 516.8% to $3.7 billion. This was observably brought by the missing litigation charge amounting to $2.76 billion the year before (9). Without this dispute, Starbucks could have grown its operational cash flow to $3.4 billion in fiscal 2014, and experience continuing growth of 11% to $3.75 billion in fiscal 2015.

In fiscal 2015, Starbucks allocated 96.7% of its free cash flow to dividends and share repurchases. Excluding Starbucks’ $3 billion ordeal in fiscal 2014, Starbucks paid out 78.6% of its free cash flow in the past three years.

Market performance

(Starbucks Performance Comparison Graph, annual filing)

In the past five years, Starbucks provided a total return of 22.4% while the broader S&P 500 market provided 14.56%. Year to date, Starbucks returned -9.7% while 6.75% for the latter (10).

Valuations

Starbucks had a trailing 12-month price-earnings (P/E) multiple 29.9 times (24 for its industry median), price-book (P/B) value 13.7 times (2.67 industry median) and price-sales (P/S) multiple of 3.9 times (0.97 industry median) (11). The company also had a trailing 12-month 1.49% dividend yield with 43% payout ratio and 0.3% buyback ratio.

Conclusion

Starbucks demonstrated an outstanding growing business. The company stated that it considers its CAP region business in its early stage and therefore may deliver more growth. Meanwhile, the recent three quarters revealed a slowing growth not only in the region but in all (region) segments.

Nonetheless, Starbucks does not rest on its laurels and wants to pursue more stores in China. The company even hopes that China could one day surpass its U.S. business.

RBC Capital Markets on Wednesday indicated Starbucks' shares are outperforming and lowered its price from $68 to $64. Using historical earnings multiple and the established five-year profit growth rate, I arrived at a $68 per share price.

In summary, Starbucks is a BUY for aggressive investors with a target price of about $65 a share.

Notes

(1) Quarterly filing: Americas included the closure of 132 Target Canada licensed stores in the second quarter of fiscal 2015.

(2) Annual filing: Comparable store sales includes only Starbucks® company-operated stores open 13 months or longer. Comparable store sales exclude the effect of fluctuations in foreign currency exchange rates.

(3) GuruFocus data.

(4) Annual filing.

(5) Annual filing: Americas included the U.S., Canada and Latin America.

Starbucks also had nonreportable segments: Teavana, Seattle's Best Coffee, Evolution Fresh and its Digital Ventures as well as developing businesses such as the Starbucks Reserve® Roastery & Tasting Room, which are combined and referred to as All Other Segments.

(6) Annual filing.

(7) Annual filing: "Other" primarily consists of royalty and licensing revenues, beverage-related ingredients, ready-to-drink beverages and serve ware, among other items.

(8) Annual filing: Starbucks customers can also place orders in advance for pick-up at certain participating locations in the U.S.

(9) Annual filing: The litigation charge of $2,784.1 million in fiscal 2013 reflects the charge we recorded as a result of the conclusion of the arbitration with Kraft. This charge included $2.227 billion in damages and $556.6 million in estimated interest and attorneys' fees. The $20.2 million litigation credit recorded in fiscal 2014 reflects a reduction to estimated prejudgment interest payable associated with the Kraft arbitration as a result of paying obligation earlier than anticipated.

Wall Street Journal: The dispute centered on an agreement Starbucks entered with Kraft in 1998 to distribute and market Starbucks brand coffee in U.S. grocery stores — and, later, in overseas markets.

(10) Morningstar data.

(11) GuruFocus data.

Disclosure: I do not have shares in Starbucks.

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About the author:

Mark Yu
A doctor in physical therapy (DPT) with a passion for finance. Value seeker. Long only. Global investing. Long-term investing.

Attempts to dissect company filings one company a day.

For quicker reading--jump ahead to an article's conclusion.

One company (review) a day keeps the speculation (hopefully) away.

Would typically invest $500 to $3000 of own money per buy recommendation.

Visit Mark Yu's Website


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