Company Background (sourced from Yahoo! Finance):
Starbucks Corporation operates as a roaster, marketer, and retailer of specialty coffee worldwide. As of September 30, 2012, the company operated 9,405 company-operated stores and 8,661 licensed stores. Its stores offer regular and decaffeinated coffee beverages, Italian-style espresso beverages, cold blended beverages, iced shaken refreshment beverages, premium Tazo teas, packaged roasted whole bean and ground coffees, Starbucks VIA Ready Brew soluble coffees, Starbucks coffee and Tazo tea K-Cup portion packs, Starbucks Refreshers beverages, juices, and bottled water. The companys stores also provide various food items, including pastries, prepared breakfast and lunch sandwiches, oatmeal, and salads. In addition, it licenses the rights to produce and distribute Starbucks branded products to The North American Coffee Partnership with the Pepsi-Cola Company, as well as licenses its trademarks through licensed stores, grocery, and national foodservice accounts. The company offers its products under the Starbucks, Tazo tea, Seattles Best Coffee, Starbucks VIA Ready Brew, Starbucks Refreshers, Evolution Fresh, La Boulange, and Verismo brand names. Starbucks Corporation has a strategic agreement with Danone to create and develop a line of dannon-branded fresh dairy products.
Analysts expect Starbucks to grow earnings 19.78% per year for the next five years and I've assumed they can grow at 2/3 of that, or 13.19%, for the next 3 years and continue to grow at 3.50% per year thereafter. Running these numbers through a three stage DCF analysis with a 10% discount rate yields a fair value price of $79.95. This means the shares are trading at a 4.8% discount to the discounted cash flow analysis.
The Graham Number valuation method was conceived of by Benjamin Graham, the father of value investing, and calculates the maximum price one should pay for a company given the earnings and book value. Starbucks earned $2.09 per share in the last twelve months and has a current book value of $7.64. The Graham Number is calculated to be $18.95, suggesting that Starbucks is overvalued by 301.6%.
Average High Dividend Yield:
Starbucks' average high dividend yield for the past 3 years is 1.86% and for the past 4 years is 1.70%. This gives target prices of $45.20 and $49.51 respectively based on the current annual dividend of $0.84. The average high dividend yield has been fairly consistent over the 4 years that Starbucks has paid a dividend and given the projected growth of the company and potential for dividend growth I believe it will probably stay around the current averages. I'll use an average of the 2 giving a target yield of 1.78% with a $47.35 price target. Starbucks is currently trading at a 60.8% premium to the average high dividend yield valuation suggesting it's well overvalued.
Starbucks' average low PE ratio for the past 5 years is 20.20 and for the past 10 years is 26.37. This corresponds to a price per share of $45.05 and $58.80 respectively based off the analyst estimate of $2.23 per share for fiscal year 2013. The 10 year low PE ratio is skewed a bit high due to the higher PE ratios it's stock was commanding in the early 2000's, and while the 5 year average is also quite high, it's not outrageous for a company projected to growth earnings at almost 20% per year for the next 5 years. I'll use the 5 year average low PE ratio for my target entry price calculations. Starbucks is trading at a 69.0% premium to this price.
Average Low P/S Ratio:
Starbucks' average low PS ratio for the past 5 years is 1.35 and for the past 10 years is 1.82. This corresponds to a price per share of $30.14 and $40.55 respectively based off the analyst estimate for revenue growth from FY 2012 to FY 2013. The price targets don't include effects due to potential share buybacks, rather it's just based off the analyst estimate for revenue and growth to be a bit conservative. Currently, their current PS ratio is 3.97 on a trailing twelve months basis. For the sake of being conservative I'll use the 5 year average of 1.35 in my target entry price calculation. Starbucks is currently trading at a 152.5% premium to this price.
Dividend Discount Model:
For the DDM, I assumed that Starbucks will be able to grow dividends for the next 5 years at the lowest of the 1 or 3 year growth rates or 15%. In this case that would be 15.00%. After that I assumed they can continue to raise dividends for 3 years at 75% of 15.00%, or 11.25%, and in perpetuity at 3.50%. The dividend growth rates are based off fiscal year payouts and don't necessarily correspond to quarter over quarter increases. To calculate the value I used a discount rate of 10%. Based on the DDM, Starbucks is worth $23.97, meaning it's overvalued by 217.6%.
Starbucks' trailing PE is 36.44 and it's forward PE is 28.51. The PE3 based on the average earnings for the last 3 years is 49.11. I like to see the PE3 be less than 15 which Starbucks is currently well over. This is mainly due to the hyper growth that Starbucks is still undergoing as they've grown earnings at a 51% annualized rate over the past 3 fiscal years. Compared to it's industry, SBUX seems to be undervalued versus DNKN (38.34) but overvalued vesus MCD (17.74). All industry comparisons are on a TTM basis. Starbucks' PEG for the next 5 years is currently at 1.73 which has SBUX undervalued versus DNKN (1.83) and MCD (2.08). A lower PEG ratio is better because it means you're paying less for every dollar of growth the company achieves.
Starbucks' gross margins for FY 2011 and FY 2012 were 57.9% and 56.5% respectively. They have averaged a 39.8% gross profit margin over the last 10 years. Their net income margin for the same years were 10.7% and 10.4%. Since 2003 their net income margin has averaged 7.3% with a low of 3.0% in FY 2008. I typically like to see gross margins greater than 60% and at least higher than 40% with net income margins being 10% and at least 7%. While their gross margin isn't quite at the 60% level it's been fairly stable and is very close to the 60% mark. Their net income margin over the long-term is just over the 7% minimum although I'd like to see the greater than 10% margins from the last 2 fiscal years continue on. Since each industry is different and allows for different margins, I feel it's prudent to compare SBUX to its industry. For FY 2012,Starbucks captured 109.1% of the gross margin for the industry and 106.3% of the net income margin.
Starbucks started off the decade by growing their shares outstanding which is fairly typical for a company that is still growing as fast as they were then, but starting in FY 2005 had a 4 year run of decreasing shares outstanding. However, since FY 2009 shares outstanding have grown every year. I'd like to see a bit more consistency in their shares outstanding as it seems that the four years of net buybacks went largely for naught as they have since increased. Overall they have decreased their shares outstanding by 2.8% since FY 2002 for an average annual decline of 0.28%. I'd like to see either a firmer commitment by management to repurchasing shares or to purchase just enough to negate dilution through stock incentives to employees.
A negative number for the % change value means shares were bought back by the company and a positive value means the shares outstanding increased.
Starbucks isn't even a dividend challenger as they only have 4 consecutive years of dividend increases. However, the next increase should bring them up to dividend challenger status. They have increased the dividend at a 23.5% and 54.0% rate for the last 1 and 3 year periods. Dividend increases are based off fiscal year payouts and don't necessarily correspond to annual payouts. Their payout ratio based off EPS has averaged 29.6% over the last 3 years.
Baxter has done a great job managing their cash flow and have been able to turn 56.4% of their operating cash flow into free cash flow over the last 5 years and 42.9% into FCF after dividends over the last 3 years. Their free cash flow has grown from $250.9M in 2007 to $894.1M in 2012, good for a 29.8% annualized increase while their free cash flow after dividends has from from $250.9M to $381.1M over the same time for a 8.7% annual increase. The free cash flow payout ratio has averaged 36.6% since initiating their dividend in FY 2010. I expected to see better numbers on the cash flow side than this. They have increased CAPEX over the last few years and it took up almost 50% of their operating cash flow for FY 2012. SBUX is still in expansion mode but I would like to see the ratios get a bit better.
Return on Equity and Return on Capital Invested:
SBUX's ROE has averaged a solid 21.4% over the last 5 years and 21.5% over the last 10 years. Starbucks' ROCI has averaged just 15.4% over the last 5 years and 15.5% over the last 10 years. That's some fairly consistent long-term returns. The ROCI tracked ROE until FY 2005 when they started using debt to further expansion. I don't necessarily look for any absolute values for ROE or ROCI but rather fairly stable or increasing levels which Starbucks has shown to be able to increase their ROE and ROCI. Management has done a great job fueling expansion through organic growth and other capital means than the debt markets. Their overall debt level has increased since the early 2000's but has since leveled off around $550M. Even better news for shareholders is that the equity stake has grown significantly over that time. Their total debt-to-equity ratio has averaged 0.21 over the last 10 years as well as the last 5 years, although the 5 year average is skewed higher due to the 0.51 level in FY 2008. Their balance sheet is very clean and there's no worries here unless management decides they need to take on more debt, which I don't expect that to happen at any significant levels.
Revenue and Net Income:
Since the basis of dividend growth is revenue and net income growth, we'll now look at how Starbucks has done on that front. Their revenue growth since 2002 has been excellent with a 15.0% annual increase while their net income growth has been even better at 20.5% per year. This has led to their net profit margin increasing over time from 6.5% to 10.4% over the last 10 years. I wouldn't expect net income to continue growing much faster than revenues going forward, but if they can at least hold steady or make slight improvements then the business will be just fine.
The average of all the valuation models gives a target entry price of $48.26 which means that Starbucks is currently trading at a 57.7% premium to the target entry price. I've also calculated it with the highest and lowest valuation methods thrown out. In this case, the DCF and Graham Number valuations are removed and the new average is $47.78. Starbucks is trading at a 59.3% premium to this price as well.
Assuming that Starbucks can grow their earnings and dividends at the rates that I assumed, you're still looking at solid returns over the next 5 years. In 2018, EPS would be $4.59 and slapping an average PE of 31.54 gives a price of $144.74. Over the next 5 years you'd also receive $6.51 in dividends for a total return of 198.7% which is good for a 14.7% annualized rate if you purchase at the current price. If you purchase at my target entry price of $48.26, your projected 5 year total return jumps to 313.4% for an annualized return of 25.7%. Benjamin Graham taught that it's best to have a margin of safety in case things don't turn out how you expect. Given the high assumed PE ratio of 31.54 I don't think that's good to project another 5 years into the future as growth will most likely not be able to keep up. Dropping the PE ratio to 20 would give annualized returns of 5.2% at current prices and 15.3% at the target entry price.
According to Yahoo! Finance the 1 year target estimate is at $80.04 suggesting about 5.2% upside from Friday's close. Morningstar has Starbucks rated as a 3 star stock meaning suggesting that it's trading on par with their fair value estimate.
The growth prospects for Starbucks are immense as they continue to expand their store count and are expanding into the Asian markets with their Teavana stores. The decision to purchase Teavana and La Boulange, a bakery, should yield good growth going forward. America and the rest of the developed world are hooked on caffeine in some form or another and I don't think I've ever passed a Starbucks that didn't at least have a few people there no matter the time. Heck I've personally gone with my wife at least twice to Starbucks that were closed just to then try and find another Starbucks nearby. They get to sell a legal substance that is addictive as heck and in the rush that most people find themselves in, I imagine plenty of people will be okay paying $4 for a muffin to go with that $5 cup of coffee from Starbucks.
As a pure dividend growth stock, Starbucks is much like Visa in that it just doesn't fit the mold. This would be more of a total return investment but if the growth does play out an investor won't be disappointed. I expected to see the dividend growth metrics to come out better than they did but their cash flow and payout ratios aren't as appealing after further examination. At current prices I don't think I could invest but if the yield gets close to the 2% level then I'd be interested in laying down some of my capital. As a dividend growth investment, or even an investment in general, Starbucks' current valuations reminds me of Warren Buffet's quote "I don't look to jump over 7-foot bars: I look around for 1-foot bars that I can step over." I don't expect my forecasts or analysts forecasts to be 100% right, but at current prices the growth is a must in order to earn a solid return. Before I started really examining Starbucks, I was expecting to see stellar numbers with huge room for growth and the potential to be the next McDonald's (MCD) as a dividend growth investment. The potential is still there though but I just don't feel comfortable investing there right now.
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What do you think about Starbucks Corporation. as a DG investment? How do you think the long-term dividend growth prospects are?