Sunday, September 22, 2013

Starbucks (SBUX) Dividend Stock Analysis

I've been trying to take a look at some of the next potential dividend growth champions that can string off a 40+ year record such as Johnson & Johnson or Coca-Cola or Proctor & Gamble.  I want the core of my portfolio to be made up of the normal stalwarts, but I believe there's a place for at least some position in some of the combination high growth businesses that also are growing their dividends, even though their streaks are fairly short.  Last month I took a look at Visa, which fits the bill of the high growth and high dividend growth company that I'm looking for.  I like their prospects so much that I also initiated a small position.  Today I want to look at another budding dividend growth candidate, Starbucks (SBUX).  Starbuck's closed trading on Friday, September 20th at $76.12 giving a current yield of 1.10%.  So here's a little reading for you while you sip your Starbucks this morning.

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 company’s 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, Seattle’s 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.

DCF Valuation:

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.

Graham Number:

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.


 Average Low PE Ratio:

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%.

PE Ratios:

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.

Fundamentals:

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.

Share Buyback:

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.

Dividend Analysis:

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.


Forecast:



The chart shows the historical high and low prices since 2001 and the forecast based on the average PE ratios and the expected EPS values. I have also included a forecast based off a PE ratio that is only 75% of the average low PE ratio.  I like to the look to buy at the 75% Low PE price or lower to provide for a larger margin of safety, although this price doesn't usually come around very often. In the case of Starbucks, the target low PE is 23.28 and the 0.75 * PE is 17.46.  This corresponds to an entry price of $70.34 based off the expected earnings for FY 2013 of $2.23, with a 75% target price of $33.79.  Currently Starbucks is trading at a $42.33 premium to the 75% low PE target price and a $5.78 premium to the average low PE price.  If you believe the analyst estimates are pretty close and that it will continue to trade in it's historical PE ranges, then Starbucks is currently on the high end of it's typical PE ranges.

Conclusion:

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.

To check out more reports check out my Stock Analysis page.

What do you think about Starbucks Corporation. as a DG investment?  How do you think the long-term dividend growth prospects are?

10 comments:

  1. If you had the choice, would you rather invest in MCD now, or at the beginning of its current dividend growth streak?

    SBUX is going to be around for a long, long time. We are witnessing a MCD-like stock at the beginning of its dividend growth run, instead of at its mature stage.

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    Replies
    1. The Executioner,

      I have to agree on that one I just don't think the value is quite there right now. If the price comes down a bit I'd be interested. I think SBUX has great prospects going forward but at current valuations I think too much of the growth is priced in and the growth would have to play out. I still love the company though and liked both their acquisitions of Teavana and La Boulange. Both of those should turn out real well although Teavana will be more of an international play. I wish I had jumped on it before but I just wasn't looking in that direction at the time. Now I'll be ready in case there's a drop in price.

      Thanks for stopping by!

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    2. Starbucks is priced for perfection right now. Unfortunately, it was similar to McDonald's in its early history about 10 - 15 years ago. The issue is that SBUX simply decided to pay dividends 10 - 15 years later than MCD did..

      I would say the company that could be the next MCD is actually Burger King...I have 5 - 6 MCD restaurants around my neighbourhood, but only on BK..

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    3. DGI,

      I wish it wasn't because the growth and DG prospects are strong, but I have to agree that you're having to count on the growth playing out at analyst estimates or faster. If the growth comes slower then it'll take much longer to earn a return and obtain decent yields.

      I never really liked BKW when I was a teen and when I was in college, but I recently gave them another shot and there food seems much better. BKW is interesting and I might have to take a look at them sometime in the future.

      Thanks for stopping by!

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    4. The Executioner: The question is, was MCD at a 36 P/E when it started its dividend policy? I'm not one for buying a dividend stream at any price. At a 1% yield like SBUX has you can have nice raises that don't move the yield much.

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  2. I am just getting back from Seattle where I visited the very first Starbucks. I am an avid drinker of their coffee and love the company but also feel they are a little overvalued. I owned 100 shares around a cost of $12/share and sold them for a small profit several years ago. I am kicking myself now but cant bring myself to pay the current prices for their stock. Thanks for the analysis.

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    Replies
    1. AAI,

      Hope you enjoyed your trip. I want to get up to Seattle and Portland, but it'll have to be a summer trip.

      I've never really drank much coffee or their sugar with a splash of coffee, but I know that many many people do. The stores are always packed and most people can't go without their daily Starbucks. There's a reason that cutting out the daily Starbucks is mentioned so often if you're trying to save money, although I think there's much bigger fish to fry than your daily coffee. I just wish some of their ratios were a bit better, specifically their payout both off EPS and FCF. It's still not anything to worry about as they aren't at high levels but I expected them to be lower. Love the company and would like to get a hold of some shares, but just not at current prices. Of course we always want lower prices.

      I hate the anchoring effect that our mind goes through. I've had a tough time trying to add to positions because I keep thinking back to the price per share from a few years ago, when the important thing is really the value per share. I'm getting better at this though.

      Thanks for stopping by!

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  3. The challenge with the Dividend Upstarts as I call them (ie large cap companies that have small yield, newly introduced dividends, but strong growth) is whether that growth is sustainable over the medium to long term. Otherwise you get suckered into small yield that just remains small. Starbucks looks to have significant potential to me. Revenue growth and Profit are surprisingly strongly growing. While the stock doesn't have a tailwind similar to Visa in my view (ie trends converging to drive demand), the stock looks like an interesting one to consider at some point when its a little better valued.

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    Replies
    1. Integrator,

      When you have to rely on medium to long term growth rates that are elevated for the investment to pan out then you're much more at risk. Will KO and PG consistently be able to provide between 5-10% growth every year, I'd say they probably will. But forecasting extended 10%+ growth over the long term for SBUX, I'd say they probably will but it's not as sure of a thing. The more growth oriented the company the bigger margin of safety that an investor should require. I really like SBUX the company, but at current valuations I don't like it so much. One day the valuation will come down, maybe with the next debt ceiling debate, but for now I'll have to pass.

      Thanks for stopping by!

      Delete
  4. Good review of SBUX.
    They have great growth potential especially in China where they are expanding fast. Not talked much about... they are testing wine and beer sales. They realized 80% of their sales comes before noon. They have all that real estate and manpower being under utilized. If they get beyond testing it in a couple towns and roll that out that would probably get me back in as a shareholder. They seem to be taking their time with that.
    I owned them for a number of years and sold them last month.

    Why did I sell? Because they were a 1% yielding 36 P/E ratio company. There are other companies out there that are undervalued, good (but not great growth prospects) and a better yield.

    ReplyDelete