Investment overview
Starbucks Corp. (SBUX, Financial) has been on my investment radar for the last several years. The stock has not disappointed in terms of shareholder returns.
Year to date, the stock is 5% higher, but has corrected by 10% in the recent past from highs of $64.6. I see this correction as a good opportunity to accumulate this long-term value creator.
With the company’s third-quarter results scheduled to be announced on July 27, the correction presents a good entry point before quarterly numbers are a potential upside trigger.
Before I discuss the key positives, I must mention Starbucks is a low volatility stock with a beta of 0.65, which is one of the reasons to consider this stock when the broad markets look stretched.
Attractive valuation
For fiscal 2017, Starbucks expects GAAP earnings per share of $2.06 to $2.10. Considering the mid-range of the guidance, the stock is trading with a price-earnings ratio of 28. Further, analyst estimates suggest 15% EPS growth for fiscal 2018, which would imply EPS of $2.4. The stock, therefore, trades at 24.4 times fiscal 2018 EPS.
The valuation is attractive for several reasons.
First, Starbucks has a dividend payout of $1 per share and a current dividend yield of 1.7%. I expect the company’s dividend payout to swell in the coming years.
Second, Starbucks has created incremental shareholder value though stock buybacks. I believe these buybacks will increase in the coming years on the back of strong fundamentals and robust operating cash flows. The company repurchased 11.3 million shares of common stock during the second quarter.
Third, analyst estimates suggest Starbucks is likely to see EPS growth of well over 10% in the long term, which I believe is likely.
Considering these key factors, Starbucks is attractive for exposure at current levels. The company’s low beta also adds to its appeal. If broad markets decline and Starbucks is lower by another 5% to 10% from current levels, further accumulation can be considered.
Clear growth opportunities
To provide insight on the company's potential growth, I will use some numbers from its second-quarter results. The first growth trigger for Starbucks is China and Asia Pacific.
For the second quarter, the company reported revenue of $769 million, 13% growth from revenue of $678 million in second-quarter 2016 in the Asia Pacific region. In my view, strong growth will continue from China and India in the next three to five years and will be one of the key factors contributing to the company’s earnings growth.
In the second quarter, the operating margin from China and Asia Pacific increased 380 basis points due to transitioning to China's value-added tax structure and sales leverage.
While Starbucks opens new restaurants at a rapid pace in China and the Asia Pacific, the initial operating cost is likely to be higher. As these restaurants begin to contribute to growth and steadily increase comparable sales, I expect the operating margin to witness further expansion. In the second quarter, comparable restaurant sales increased 3% globally and 7% in China. I expect this growth to be well over 5% for China and India.
The company’s operating margin expanded to a record of 17.7% for the quarter. The primary margin driver remains sales leverage. With technological innovations being introduced, comparable restaurant sales growth will continue to remain robust, supporting operating margin expansion.
Therefore, earnings growth is likely to be supported by steady revenue growth coupled with operating margin expansion. While China and the Asia Pacific will be a key growth driver in the near term, the 3% comparable restaurant sales growth in America is also promising.
Conclusion
Starbucks has been a value creator over the years. With healthy dividends, continued share buybacks and steady growth, the stock is likely to deliver more shareholder returns in the coming years.
I see the recent correction as a good opportunity to accumulate. With third-quarter results on July 27, I believe the stock has a near-term upside trigger.
Disclosure: No positions in the stock.
