Starbucks is the preferred coffee shop for both U.S. and Chinese customers when they want to enjoy coffee away from home. It is also the leader in brand loyalty, customer visits, and frequency of visits in these two major markets. Starbucks is also among the top 30 most valuable brands in the world. I prefer companies with a strong brand, but does that mean it's the right time to invest in Starbucks? This is what I will investigate in this analysis.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should start by mentioning that I do not own shares in Starbucks, and I never have. Personally, I prefer local coffee shops over Starbucks. However, like everyone else, I have also visited Starbucks on multiple occasions. Nevertheless, my preference for local coffee shops will not influence my analysis of Starbucks, as I will remain unbiased. If you are interested in viewing or copying my portfolio, you can do so here. If you want to purchase shares or fractional shares of Starbucks, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100. Click on the banner below to get started.
The Business
Starbucks was founded in Seattle, USA in 1971 with a single shop. Now it has grown to become the largest coffee chain in the world, operating 36.000 stores in more than 80 countries and serving over 100 million customers daily worldwide. Starbucks has two types of stores: company-operated stores (52% of all stores in 2023) and licensed stores (48% of all stores in 2023). Starbucks generated 82% of its revenue in 2023 from company-operated stores, while licensed stores contributed 11% of the revenue. Licensed stores have lower gross profit margins but higher operating margins than company-operated stores. Under the licensed store model, Starbucks receives a margin on branded products and supplies sold to the licensed store operator, along with a royalty on retail sales. Licensees are responsible for operating costs and capital investments, which offset the lower revenue that Starbucks receives. Starbucks is more than just coffee shops. They have also made a deal with Nestlé, granting Nestlé the rights to market Starbucks Consumer Packaged Goods and Foodservice products globally. This means that you can now purchase Starbucks coffee beans at your local supermarket, among other items. Starbucks also has a partnership with PepsiCo regarding ready-to-drink products. Their largest market is by far the United States, followed by China. It is easy to see why Starbucks has a strong competitive advantage. They have built a powerful brand moat, as consumers know and trust the brand.
Management
The CEO is Laxman Narasimhan. He joined Starbucks as the Chief Executive Officer-elect on October 1, 2022, and assumed the role of CEO on March 20, 2023. Prior to joining Starbucks, he was the CEO of Reckitt, where he spearheaded a significant transformation leading to sustainable growth. He did so by re-imagining some of Reckitt's most notable brands and doubling Reckitt's e-commerce business. He has also been credited for his ability to adjust supply and production to meet the unprecedented high demand for Reckitt's products during the COVID-19 pandemic. This demonstrates his capability to exceed expectations in one of the most complex operating environments. Prior to joining Reckitt, he held various positions at PepsiCo and McKinsey. He has several degrees: a degree in Mechanical Engineering from the University of Pune in India, a Master of Arts in German and International Studies from the University of Pennsylvania, and a Master of Business Administration in Finance from the University of Pennsylvania. Laxman Narasimhan is also a member of the Board of Directors at Verizon. He is highly regarded as a leader, and when he announced his departure from Reckitt, the shares fell by 4%. While we cannot judge Laxman Narasimhan yet, I feel comfortable with him leading Starbucks. With nearly 30 years of experience in leading and advising global consumer-facing brands, he is renowned for his operational expertise.
The Numbers
The first number we will look into is the return on invested capital, also known as ROIC. We aim to review a 10-year history, with all figures ideally exceeding 10% each year and showing an upward trend annually. Starbucks has delivered impressive financial results over the past decade. It was only during the pandemic, Starbucks achieved a Return on Invested Capital (ROIC) of under 28%. It is even more impressive that Starbucks has managed to achieve a Return on Invested Capital (ROIC) above 70% in three of the past five years, except for 2020 and 2021, which was due to the pandemic. Not many companies consistently deliver a ROIC above 70%, which is why these numbers are very impressive.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. It is curious to see that Starbucks has had negative equity since 2019. The reason for this is that Starbucks has used debt to repurchase shares. It might make sense if the stock is significantly undervalued and the debt has a low interest rate. However, with higher interest rates, I would like to see Starbucks prioritize paying off debt instead.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Starbucks has consistently generated positive free cash flow since 2015, including during the pandemic and the challenging year of 2022. It is a good sign that Starbucks managed to deliver its third-highest free cash flow in the past ten years in 2023, and hopefully, it will continue to increase moving forward. The levered free cash flow margin dropped in 2022. Although it did recover slightly in 2023, it has not returned to the level that we have been accustomed to since 2015. I would like to see the levered free cash flow margin increase in fiscal year 2024. Free cash flow yield is also below the ten-year average, indicating that the shares are not trading at a discount. However, we will revisit this later in the analysis.
Debt
Another important aspect to investigate is the level of debt, specifically whether a business has manageable debt that can be paid off within a period of 3 years. We calculate this by dividing the total long-term debt by earnings. After performing the calculation on Starbucks, I can see that Starbucks has 3,28 years' worth of earnings in debt. It is a bit higher than I would prefer, and I hope that Starbucks will stop acquiring additional debt to repurchase shares, as they have been doing since 2019, and prioritize paying off debt instead.
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Risks
Based on my findings so far, I believe that Starbucks is a reputable company. However, no investments are without risk, and Starbucks also has its share of risks. One risk that Starbucks mentions in its annual report is macroeconomics. Starbucks mentions that their operating results have been and will continue to be subject to a number of macroeconomic and other factors, many of which are largely outside of the company's control. If there is a prolonged economic slowdown or recession in some of Starbucks' key markets, it will affect their business. The reason is that their customers will have less money for discretionary purchases, which could reduce their purchases of Starbucks products as they would buy less or switch to cheaper competitors. One example of this occurred in 2008 when Starbucks experienced a 28% decrease in profits, leading to the closure of 900 stores. Thus, if we experience a prolonged economic slowdown, it could once again impact Starbucks.
Unionization. Starbucks has an ongoing conflict with unions, as thousands of employees have decided to unionize to improve their pay and working conditions. The conflict has been contentious. In multiple cases, federal courts have ordered Starbucks to reinstate workers who had been fired after leading unionization efforts at their stores. Regional offices of the National Labor Relations Board have issued at least 120 complaints against Starbucks for unfair labor practices. These include refusal to bargain and reserving pay raises and other benefits for non-union workers. Starbucks and the union organizing its US workers have agreed to initiate discussions with the goal of reaching labor agreements. However, predicting the outcome and the impact on Starbucks in the present and future is challenging.
Competition. Starbucks operates in a highly competitive market where customers choose among specialty coffee retailers and shops primarily based on product quality, brand reputation, service, convenience, and price. Starbucks is facing competition from large competitors in the quick-service restaurant sector, as well as from both well-established and start-up companies in numerous international markets. Furthermore, Starbucks also competes with restaurants and other specialty retailers for prime retail locations and qualified personnel to operate both new and existing stores.
Reasons to invest
Starbucks also has a lot of potential for business growth. One significant catalyst is the potential growth in China. Starbucks has been in China for 25 years. However, according to management, they believe that they are still in the early stages of their growth story in China. Management has mentioned that they remain very confident in the Chinese market long term. Management believes that the Chinese market will become much larger and more tiered as per capita consumption continues to increase and the market matures. Starbucks now has nearly 7.000 stores in China and believes that they have built a terrific brand in the country. They are well on track to reach their target of 9.000 stores by 2025, and the management continues to have full confidence in the market opportunity. Management has mentioned that they continue to see enormous potential in China's premium market and believe that no one is better positioned than Starbucks to lead in this space.
Another growth potential is Starbucks Rewards. Starbucks Rewards is a loyalty program where customers can earn points that can be redeemed for complimentary beverages. Reward programs incentivize customers to engage more with the brand, resulting in increased visit frequencies. Starbucks Rewards is growing rapidly and now boasts over 34 million members. Management mentioned that Starbucks Rewards members are visiting its stores more frequently and increasing their spending each time they come. As a result, the spending per member reached a record high in 2023. Starbucks has implemented targeted offers aimed at attracting occasional customers to its loyalty program. It is significant as Starbucks has observed over time that Starbucks Rewards members develop a routinized long-term relationship with its brand, leading to an increase in both average spending per transaction and the frequency of transactions.
More stores. Starbucks is expanding its global store count to over 38.000 in fiscal year 2023, indicating a 7% growth compared to 2022. Management has mentioned that they are pleased with the pace of their new store openings and the strong unit economics. Management mentioned that their most recent age class of company-operated new stores in the US is averaging unit volumes of approximately $2 million with ROIs of approximately 50%, indicating that opening stores will lead to long-term growth. Starbucks expects to increase the number of its stores in the U.S. by 4% and its international stores by 10% in fiscal year 2024.
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Valuation
Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 3,58, which is from the fiscal year 2023. I have selected a projected future EPS growth rate of 13,6%. Finbox expects EPS to grow by 13,6% in the next five years. Additionally, I have selected a projected future P/E ratio of 27,2, which is double the growth rate. This decision is based on Starbucks' historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $86,15. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Starbucks at a price of $43,08 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 6.799, and capital expenditures were 2.413. I attempted to analyze their annual report in order to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 1.689 in our calculations. The tax provision was 1.352. We have 1.132,2 outstanding shares. Hence, the calculation will be as follows: (6.799 – 1.689 + 1.352) / 1.132,2 x 10 = $57,07 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Starbucks' free cash flow per share at $3,86 and a growth rate of 13,6%, if you want to recoup your investment in 8 years, the Payback Time price is $57,18.
Conclusion
I believe that Starbucks is an intriguing company, and I was pleasantly surprised by their high ROIC (Return on Invested Capital). We cannot judge the management yet, but I feel confident that Starbucks has found the right person to drive future growth. Starbucks may be facing some short-term headwinds related to macroeconomics, but these conditions are expected to improve over time. Therefore, macroeconomics is not something that worries me. We don't know how unionization will affect Starbucks, if at all, but I believe it will likely lead to higher wages, impacting its profit margins. I believe that unionization is worth monitoring. Starbucks is operating in a highly competitive market, and recently McDonald's has introduced CosMc's, adding another competitor to the market. Competition will be a long-term risk for Starbucks, but so far, they have managed to outperform their competitors, and there is no indication that this will change. Starbucks believes it has a long runway for growth in China. Once the Chinese consumer starts spending again, it should bode well for Starbucks. Starbucks is also expanding its loyalty program, and loyal customers' spending continues to reach new heights. If Starbucks managed to bring its occasional customers into its loyalty program, it would be very good for the future business. Finally, Starbucks continues to open new stores and plans to continue doing so, which is another growth catalyst. I would love to buy Starbucks shares at $57, as it would give me a 50% discount on two out of three calculations. I might even purchase Starbucks at a higher price if it is trading below the intrinsic value based on all three of my calculations.
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