Summary
Basil Leaf Capital rates Starbucks a BUY. Starbucks is a great performing company that has fallen into a reasonable valuation. As a company they are performing at an amazing level of operation and growth. The company is amazing at getting return on its invested capital and will continue to grow and operate well.
Understanding Starbucks as a Business
Starbucks Corporation, a global coffeehouse chain. Starbucks has established itself as a prominent player in the coffee industry and, over the years, has expanded its product offerings, footprint, and revenue streams. In this overview, we’ll delve into Starbucks’ business and explore its primary revenue streams and the growth opportunities it is capitalizing on.
Primary Revenue Streams:
Company-Operated Stores: Starbucks’ flagship revenue stream is its company-operated stores. These stores, commonly found on street corners, in shopping centers, and at airports worldwide, offer a wide range of coffee and tea products, complemented by a menu of breakfast and lunch items, pastries, and snacks. Sales in these stores are driven by customer foot traffic and the loyalty of its patrons. 51% of the stores are company operated and 49% are licensed stores. The US and China combined make up 61% of their store portfolio.
Licensed Stores: Starbucks expands its reach through licensed stores, including franchises, grocery stores, and other partners. These licensed locations operate under the Starbucks brand and serve a variety of Starbucks products, providing an additional revenue stream. Starbucks often shares profits from these stores with its licensing partners.
Consumer Packaged Goods (CPG): Starbucks’ CPG division extends its influence to households through the sale of packaged coffee, tea, and ready-to-drink beverages. The company markets its products through grocery stores, convenience stores, and e-commerce platforms. By offering coffee lovers the chance to enjoy Starbucks products at home, the CPG segment enhances its revenue streams.
Digital and Mobile Channels: Starbucks is heavily invested in its digital presence and the use of mobile technology for sales. The Starbucks mobile app and loyalty program have been significant contributors to revenue. Customers can order ahead, make payments, and earn rewards through the app, which fosters customer engagement and promotes repeat visits.
International Expansion: Starbucks continues to expand its global presence by opening new stores in both developed and emerging markets. This expansion strategy contributes to revenue growth as the company taps into new markets and gains a broader customer base.
Starbucks has a massive brand moat in the market of coffee. The customer loyalty they are able to generate gives them a massive advantage they have over any other coffee company. Coffee is another inelastic product meaning that the demand doesn’t change drastically with change in price. The customer loyalty along with the inelasticity of coffee drives massive amounts of demand.
The key metrics Starbucks wants investors to look at in their earnings reports is new store openings, comparable stores sales growth, and operating earnings. When reading earnings reports it will be important to track these metrics because that is what management thinks is important to performance and what they will be focusing on.
Valuation Metrics
The finviz stock screener is a great tool to see performance metrics that are important to assess a company’s valuation.
Starbucks is valued as a $104 Billion company based on their market cap. The price to earnings ratio is around 28. The earnings are predicted to keep growing at 16% yoy over the next 5 years. This growth rate combined with the earnings ratio means that the valuation looks expensive.
FAST Graphs Analysis
The FAST Graphs software is a powerful tool used to analyze the earnings of a company compared to the share price. The black line is share price and the orange line is earnings multiplied by 15. The blue line is the average PE ratio over the time frame plotted.
Here we can see the exponential growth of earnings since the existence of Starbucks. The market has always placed a premium value on starbucks that you see with the blue line. The share price has recently declined and brought the share price between premium multiple and the fair value.
Bull Thesis
Starbucks is a premier company with premier performance. They have incredible brand loyalty along with an inelastic product. The company is still growing at a remarkable clip and they are returning value to shareholders with their dividend. Starbucks is growing earnings at 16% and returning an additional 2% via the dividend. That returns 18% which meets our goal for our portfolio of 15%.
Starbucks has room for growth within the United States and especially in the emerging markets. For example Starbucks recently opened their first store in Paraguay, and Rome. Coffee is a universal drink and people all over the world will be interested in Starbucks coffee. Starbucks shows no signs of slowing down in the store openings and the demand is there to back each store opening. Starbucks has an elite real estate analysis team determining the best locations to open stores to achieve the demand they are looking for. Another signal that the company is still in its growth phase is that its revenue is growing faster than its earnings. The operating margins are consistent and the revenue growth yoy is 24% while the earnings growth is 16%. That means they are reinvesting the cash flow into their business to grow further. When a company is investing money back into their business it is important to know how that invested money is doing. Looking at FinViz we can see that the return on investment they are getting is 29%. 29% is an amazing performance by a company and is proving that management is skilled at utilizing their free cash flow.
Bear Thesis
Starbucks is a great company however the valuation is at a premium. The growth rate should be approximately the earnings multiple of a company. Starbucks is not growing at a growth rate of 28% therefore it should be considered overvalued. This is a rule of thumb because when deciding on an investment you need to discount future earnings and earnings multiple of 28 doesn’t discount the future earning enough and it will underperform the desired rate of return.
The operating margin for Starbucks could be at risk because Starbucks employees are starting to unionize. This will cost the company a lot more in labor costs and reduce their operating margin. If the operating margins start to shrink then either earnings will start to decrease or cash they have to reinvest will start to decline. If either of these things happen then Starbucks’ valuation based on their growth and earnings should be reduced.
Rating
Basil Leaf Capital rates Starbucks a BUY. Starbucks is an elite company that is performing at an elite level. They have incredible brand loyalty and their product will be bought no matter the economic conditions. They are sustaining great operating margins and still investing in their business to grow at an amazing rate. The recent share price decline is a great opportunity to buy this company at a fair valuation. The only time that Starbucks did not trade at or above its normal price multiple is during the 2008 crisis. At that moment in time it traded at a fair value of 15. With Starbucks falling under its average PE ratio it has fallen into reasonable valuation. If the share price falls further that would be a great opportunity to buy this amazing business at an even better price. As Warren Buffet said “Its better to buy a good company at a fair price than to buy a fair company at a good price.” Starbucks is a good company at a fair valuation.