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Starbucks Corporation NASDAQ: SBUX
Date: 5/6/14
● 2 for 1 stock split March 18, 2015
Starbucks corporation is an American global coffee company based out of Seattle,
Washington. Starbucks is currently the world’s largest coffeehouse company in the
world with over 20,000 stores in 64 countries. Starbucks primarily serves hot and cold
beverages, whole­bean coffee, pastries and snacks. Starbucks uses its brand image
and ambience to help command a high margin on its sales while maintaining high sales
volume from consumer loyalty. Consumer loyalty is achieved not only through high
quality products, but also through loyalty programs such as the starbucks gold­member
card. It’s main sources of revenue come from company operated stores, licensed
stores, and consumer packaged goods.
The majority of Starbucks Corporation’s revenues come from retail locations that the
company owns. The Company is very careful to pick retail locations with highly
populated areas with large volumes of foot traffic, generally downtown, retail suburban
areas, university campuses, and office buildings. Starbucks has decided to expand
internationally using a licensing model in order to capitalize on emerging markets. The
Company is also placing a stronger emphasis on Consumer Packaged Goods, putting
more products into grocery stores and the results have been excellent. Currently,
Starbucks purchases all of its raw materials from third parties and acts only as a coffee
producer and retailer. Eventually, Starbucks plans to begin acquiring its own coffee
plantations and using these new plantations to experiment with coffee beans, ultimately
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2. hoping to continue its efforts to sell the highest quality coffee. Starbucks relies heavily
on the quality of its product and the resulting customer loyalty. There are many other
coffee options in the market, many of which are sold at significant discounts. However,
consumers are willing to pay a little extra for Starbucks because of its quality. In order to
capitalize on this loyalty, Starbucks has one of the most sophisticated and impressive
loyalty programs on the market. The program revolves around its mobile app, which
account last year for the majority of in­store mobile transactions.
Starbucks is currently the number one coffer provider in the US market. Its two biggest
competitors are McDonalds and Dunkin Donuts. Starbucks is known for delivering an
in­store experience that its competitors cannot duplicate.
Within Starbucks, the US is the biggest market followed by Canada. Starbucks is
currently attempting rapid expansion in the China/Asia Pacific region and predicts it to
overcome the number two spot in 2015.
Starbucks routinely delivers strong financial performance. Since 2001, Starbucks has
achieved revenue growth in excess of 10% every year except for three during the
recession. Starbucks has also consistently topped the 20% mark for revenue growth
during that period. Such growth has been achieved by generating revenue growth
across each of its segments (Stores and Consumer Product Goods­CPG) as well as
expanding their market share by consistently growing the number of stores and
distribution channels for CPG. The company now operates in 64 countries with an
excess of 20,000 stores worldwide. Starbuck’s stock has increased 401% in the last 5
years and has become increasingly profitable. Starbucks has grown their ROIC from
around 8% in 2008 to the current 30% they have maintained the last few years. This is
largely attributable to expanding their market share as customers have become
increasingly loyal while the recession forced competitors out of business.
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3.
Strengths
Brand Loyalty
Starbucks has tremendous brand loyalty and recognition in the marketplace. It has a
popular brand that allows it to charge a premium price to consumers. When customers
purchase a beverage from Starbucks they are immersed in a quiet, friendly atmosphere
where they can use the available free Wifi to work or relax. Starbucks has optimized its
loyal customer base through the My Starbucks Reward program where customer
receive discounts and incentives for every visit to a starbucks location. Starbucks has a
strong commitment to retaining customers.
Diverse Product Lineup
Coffee is the core product and value driver for Starbucks, but the Company has taken
multiple steps to offer more to its customers than just a cup of coffee. It has diversified
its product lineup and its offerings in store. Acquisitions of Evolution Fresh, Tazo, and
Teavana are clear examples of this initiative. These moves broaden the company’s
offerings and allow it more flexibility when expanding abroad.
Weaknesses
Uncertain International Demand
While Starbucks has not yet reached a saturation level in the United States, it must
depend upon much of its future growth to come from abroad, particularly the China/Asia
Pacific market. International demand can become uncertain because of fluctuation in
exchange rates, labor costs, changes in discretionary income, and employment rates.
Starbucks will need consistent growth in its international markets to meet growth
forecasts. Furthermore, Starbucks is completely exposed to the risk of the price of raw
materials including coffee, milk, etc. Small fluctuations in these costs impact the
margins that Starbucks is able to earn.
Price Premium
As an industry leader with a very strong brand, a cup of coffee at Starbucks is generally
more expensive than its competition. This price premium is an enormous asset during
times of prosperity, but in an economic downturn consumers are less likely to pay the
premium for the Starbucks experience. This was evident during the recession of 2008
when Starbucks was forced to close down a large chunk of stores.
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4. Opportunities
Health and Wellness
An increased emphasis has been put on healthy and natural ingredients in drinks and
meals by consumers. Starbucks is in an advantageous position to take advantage of
this consumer trend. The Company purchased the Evolution Fresh brand in 2011 in
order to expand its healthy product choices. The purchase of Teavana is also a
potential opportunity to enter the $40 billion worldwide tea market and attract health
conscious customers.
Consumer Packaged Goods
Starbucks has advertised its increased emphasis on expanding its consumer packaged
goods offerings. The Company anticipates this segment to one day rival revenue gained
from its company owned stores. This revenue segment is extremely attractive because
of high margins and consumer demand.
Different Times of the Day
Coffee is typically consumed during the morning. However, Starbucks is exploring ways
to make sure they are bringing in consumers at all times of the day. Part of the way they
hope to achieve this is by introducing new food options and even alcohol after 4pm. By
creating an appeal for consumers to step into the store well after the time they would
normally consume their coffee, Starbucks hopes they can continue to experience
growth in their revenues.
Threats
Substitutable Goods
The continued success of Starbucks in the coffee market has attracted competitors to
attempt and steal some of this market share. The most impactful threat at the moment is
McDonald’s and their “premium” line of McCafé products which offer convenience and a
lower price compared to Starbucks offerings.
From the following equation:
● Value=Nopat[1­(g/ROIC)]/(WACC­g)
We have that the value of a firm is driven by:
1. Their ability to generate a return on the invested capital (ROIC) above their cost
of capital (WACC).
2. Their ability to grow
Therefore we decided that the best way to choose our comparables would be by
comparing profitability ratios, analyst growth estimates for next 5 years, and Betas (as a
measure of risk) between potential comparable firms. Moreover, when valuing a firm
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5. using the EBITDA multiple approach one of the key assumptions we make is that
EBITDA multiple Firm1=EBITDA multiple Firm2. So we also decided to compare the
EBITDA multiples to assure a more accurate valuation. Lastly, market capitalization was
also considered but not given as much importance as we did to the previously
mentioned factors.
The following table highlights the factors considered for 8 potential comparable firms:
Ticker Mrkt Cap Ev/Ebitda ROIC Op Marg Beta 5yr g Est
SBUX 52.38 B 16.95 30.79% 15.75% 0.87 18.41%
DNKN 4.64 B 19.08 6.66% 39.36% 0.53 15.58%
MCD 99.93 B 11.05 18.91% 30.23% 0.34 7.42%
JMBA 185.45 M 15.34 8.60% ­2.4% 2.09 15%
KKD 1.16 B 19.14 12.76% 10.42% 1.55 23.5%
PNRA 4.24 B 10.27 25.78% 12.41% 1.18 17.43%
CMG 15.6 B 22.76 23.49% 16.37% 0.85 21.6%
YUM 33.48 B 12.56 21.46% 16.07% 0.7 13.98%
WEN 3.7 B 11.6 1.35% 7.91% 0.82 18.05%
* YAHOO FINANCE
The first criterion we used to discard comparables were the profitability margins. As the
table above shows, Starbucks has a ROIC of 30.79% and an Operating Margin of
15.75%. Through this analysis we were able to discard Wendy’s (WEN), Jamba Juice
(JMBA), and Dunkin’ Donuts (DNKN). The next method of elimination was to analyze
the 5 year growth estimates as well as the Betas. When compared to the rest we
noticed that McDonalds (MCD) Beta (.34) and growth estimate (7.42%) was too low, so
that firm was also discarded. Lastly, we compared the EBITDA multiples of the
remaining firms and we decided that Panera (PNRA) was too low, so that firm was also
eliminated.
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Final list of comparables:
Ticker Mrkt Cap Ev/Ebitda ROIC Op Marg Beta 5yr g Est
SBUX 52.38 B 16.95 30.79% 15.75% 0.87 18.41%
KKD 1.16 B 19.14 12.76% 10.42% 1.55 23.5%
CMG 15.6 B 22.76 23.49% 16.37% 0.85 21.6%
YUM 33.48 B 12.56 21.46% 16.07% 0.7 13.98%
* YAHOO FINANCE
To estimate the intrinsic value of Starbucks and provide a recommendation on the stock
our group used a Discounted Cash Flow Model using both the Weighted Average Cost
of Capital approach and the Adjusted Present Value approach as well as a EBITDA
Multiples approach. In order to perform our analysis we inherently had to make
assumptions concerning the growth and continued operations of Starbucks Corporation.
Revenue Decomposition
To forecast revenue we segmented revenue into three main components: company
operated stores, licensed stores, and consumer packaged goods. Each component was
then further broken down to discover what was driving revenue growth. We discovered
that the opening of new stores was more responsible for revenue growth than the
increased return from each individual store. Knowing the expansion strategy of
Starbucks allowed us to predict the number of new stores that would be opened during
the planning period. Starbucks plans to own 14,500 stores within the US Market by
2017 with an equally ambitious expansion plan abroad, primarily in the China/Asian
Pacific Region. This came out to opening 700 stores per year in the US market and a
similar number in the China/Asian Pacific Region. The next step in our projection was to
determine the growth rate of same store sales year over year. After determining both of
these numbers we were able to predict the revenue growth of the company and
licensed stores segments. The revenue growth rate of consumer packaged goods was
based on the historic growth rate of the segment as well as company releases stressing
the importance of growing this successful and high margin segment. Combining all
three segments gave us our growth rate for each year of the planning period
Balance Sheet
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7. To forecast balance sheet items, we had to pay special attention to the litigation
charges which costs about $2.8 billion. This charge is a result of Kraft lawsuit against
Starbucks due to their early termination of the agreement. This liability heavily affected
starbucks stock price. To pay this charge they acquired $750 million in long­term debt,
and included this debt in their total “cash and cash equivalents”, which resulted in an
abnormally high 2.5 billion cash balance at the end of 2013 fiscal year. We estimate that
they will continue to accumulate cash during the 2014 fiscal year. Eventually charges
will be payed in 2015. Our “cash and cash equivalents” forecasts depends on this basic
concept.
For other balance sheet items we have used ratios based on either forecasted revenue
or forecasted cost of goods sold for each fiscal year.
Income Statement
The assumptions that we made in calculating the pro forma income statement are listed
in the Appendix on the sheet named Income Statement Forecast Assumptions. We
linked a majority of line items to historical average ratios of line items compared to
revenues. Cost of goods sold as a percentage of revenue has been fairly stable in the
past five years and we took an average of this stable ratio and applied it to our
projection for the next five years. In calculating SG&A we noticed a constant downward
trend in its percentage of revenue. We applied this trend to our prediction by taking an
average decrease and applying that trend to the year 2013. The next key assumption
was predicting depreciation and amortization in the planning period. We did this by
taking the ratio of depreciation compared to net PPE and intangible assets, which was
stable in the past five years. We applied the average of this ratio to predict how
depreciation expense would be applied in the planning period.
Cash Flow Statement
The cash flow statement was created using projections and assumptions that we had
made projecting the balance sheet and the income statement. We found net earnings
from the pro forma income statement and made the same adjustments that Starbucks
made in preparing their cash flow statement.
ROIC
To calculate ROIC we used the formula NOPAT/Invested Capital. Our NOPAT was
simply calculated as the after tax operating income, but our operating income had
several assumptions included in its calculations. We started with net revenue and
subtracted total operating expenses, including store, SG&A and other operating
expenses. To this number we added “Income from Equity Investees”. After some
investigation, we discovered that this line item refers to licensing agreements that
starbucks holds. The income represented by this line includes income from companies
that Starbucks own at least 50% of and receives royalties from. As such, they can be
included in operating income. Our invested capital calculation was based on the
following: A/R + Inventories + Prepaid Expenses and other current assets + Deferred
Income Tax + PPE + Other Intangible Assets + Goodwill ­ Accounts Payable ­ Deferred
Revenue. We also calculated the invested capital without Goodwill. This means that we
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8. were able to calculate the ROIC with and without the Goodwill as well. We found that
over time, ROIC increase to about 30 percent, and continued growing to about 39
percent in our forecast. Mechanically, this occurs because our forecast anticipates a 45
percent increase in NOPAT, while our Invested capital only grows by seven percent.
The main contributor to our NOPAT growth is the aggressive expansion plan Starbucks
has been pursuing into China as well as other countries. Invested Capital lags behind
this growth due to the fact that Starbucks is increasing the number of licensed stores.
They have even gone so far as to relax the requirements for a licensed store to operate,
in order to encourage more licensed stores to open. Licensed stores require
significantly less Invested Capital on the part of Starbucks and still generate significant
returns.
FCF
Our firm free cash flows is based upon projections and assumptions made in the
previous financial statements. The adjustments that we made came from projected
changes in key line items that affected the available cash for Starbucks.
Historical Equity Beta
Beta is an important factor of the CAPM analysis, which calculates the cost of equity. A
change in the Beta will affect the discount rate used in DCF analysis and thus the
intrinsic value of the company.
Our Beta assumption of 1.03 is based on ten year daily data of SBUX returns against
the S&P 500. We used a ten year beta because we believed that it most accurately
represented the long term capital structure of Starbucks Corporation.
Weighted Average Cost of Capital
In calculating the WACC, several assumptions were made. Our Equity Beta was
calculated using the relationship between Beta of Assets and Beta of Debt given the
D/E ratio. Beta of Debt (0.27) was determined using the credit rating of the company
and the cost of debt (5.06%) associated with long term corporate bonds at this credit
rating (Baa1 ­ Moody) (BBB+ S&P). Our Beta of Assets calculation is explained above.
Using this relationship we calculated a Beta of Equity in 2013 to be 1.13. For
robustness, we calculated the Beta of Equity using the different Debt­Equity ratios each
year and used this to calculate our cost of equity over time as well. Ultimately, this
allowed us to see that from 2014 onwards, our WACC would achieve a level of about
8.52% and would consequentially make a suitable assumption for our discount rate for
the planning period. Although Starbucks assumes a significant amount of debt in 2013,
this is due to a lawsuit the company currently has with Kraft foods and it is rather
unclear when they plan to pay it off. However, it is apparent that the company plans to
maintain a constant and relatively low Debt­Equity ratio given recent trends. This will
allow us to justify using the WACC for our calculation. In other words, given the
preference of the company to use a low and constant D­E ratio, we chose to ignore this
one time fluctuation in the Debt for our valuation of the company.
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9. Terminal Values
Separate terminal values were calculated for each valuation technique (WACC and
APV) for Starbucks. The Gordon Growth Model was used to calculate the terminal value
of as part of the WACC method. Our Enterprise Value calculated via the DCF method is
discounted across the range of WACC + 1% in order to provide a depiction of the
model’s sensitivity to the discount rate. Accordingly, the discount rate used to calculate
the future value of the terminal value is calculated using this same range. This range is
then inherently included in the present value calculation of the terminal value later.
Additionally, the future value terminal value is calculated across a range of growth rates.
This is done to show the terminal value’s sensitivity to a change in growth rate. Typically
the growth rate of GDP (approx. 3%) is used as the growth rate of the terminal value.
However, US GDP is currently growing at a rate of 2.2%. We feel calculating the
terminal value in light of this is more likely to reflect how the rest of the market is valuing
Starbucks long term growth. Beyond this, we calculated the terminal value over a range
of growth rates from 2.2%­2.8% in order to measure the terminal value’s sensitivity to
the growth rate. Starbucks corporation has historically exhibited a growth rate greater
than US GDP and we determined it reasonable to assume Starbucks would continue
growing above the average of GDP into the foreseeable future. Therefore, we selected
growth rate of 2.5% as the most reasonable. Ultimately, we selected the terminal value
calculated with a WACC of 8.52% and long­term growth rate of 2.5% as the best
calculation of terminal value for the WACC approach to calculate DCF. Just like the
planning period, the terminal value must be discounted to its present value. This is done
in half year segments for the same reasoning explained in the DCF section.
The APV method allows analysts to value a company without having to make
assumptions about target D/V ratios. Accordingly, the terminal value of the APV method
is calculated without the need of these ratios as well. The consolidated APV method
was selected and discounts the terminal value by a rate that captures the risk of the
company’s total cash flows. The assumptions inherent in this are that this rate does ​in
fact​ capture the risk of the company’s total cash flows and that the Ka discount rate
used is approximately the same as the Kua we are ultimately seeking to use.The final
assumption is that fluctuations in the growth of interest expense and the tax rate apart
from the growth of FCF is marginal so a single growth rate can be used to estimate the
terminal value. After these assumptions, Ka is calculated using the CAPM model and
Ba. The numerical range of 2.2%­2.8% for the long term growth rate of FCF was
selected for the same reason described in the assumptions of the WACC approach
calculation of terminal value. A range is provided to illustrate the terminal value’s
sensitivity to the growth rate. Growth rate of 2.5% was selected because Starbucks has
historically outperformed US GDP growth. The terminal value is ultimately discounted
back to today by using half year increments since our valuation occurs shortly after
Starbucks' second quarter.
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We constructed a Discounted Cash Flows model to value the cash flows obtained from
both the WACC and APV methods. This model values the cash flows back to April,
24th, 2014, the date that the quarterly Starbucks earnings report was filed. This report
marked the halfway point of the fiscal year, which ends in September. As such, we
divided our projected cash flows for 2014 by 2 and used this as our cash flow for the
remainder of the year. We then discounted this back at a rate of (1+WACC)^.5 in order
to find the present value on April 24th. We discounted the rest of our cash flows back to
this date as well in order to get the most recent and accurate valuation. Under the
WACC valuation, the enterprise valuation determined by the DCF model was $60.26
billion, which yielded our projected stock price of $78.80. The APV method yielded a
$57.57 billion valuation and a stock price of $75.47.
In our sensitivity analysis we discovered that WACC is an important factor in the DCF
valuation procedure. Our model used a WACC of 8.52% based upon calculations
through the CAPM model. A 1% increase or decrease in this WACC results in a 15%
change in the target stock price. Any variation greatly affects the firm’s equity value.
This demonstrates how critically important using the appropriate WACC is when valuing
Starbucks.
To value Starbucks in relation to its comparables we used the EBITDA Multiple
approach. This approach states that:
● EV Firm B= (EV Firm A/ EBITDA Firm A)*(EBITDA Firm B)
KKD CMG YUM
EBITDA Multiple 19.14 22.76 12.56
Starbucks
EBITDA
3.1756 B 3.1756 B 3.1756 B
Starbucks EV 60.78 B 72.27 B 39.88 B
To compensate for any variability in the operations of our comparables we decided to
estimates Starbuck’s enterprise value using 3 different EBITDA multiples. To reach a
final enterprise value we averaged the individual estimates from the previous table
(60.78B+72.27B+39.88B)/3.
Final Enterprise Value: 57.64 Billion
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Our comparable company analysis and our DCF analysis resulted in very similar
outlooks on the company stock price. The DCF using the APV resulted in a stock price
value of $75.47 and the DCF using the WACC resulted in a stock price value of $78.80.
Our analysis using comparable companies provided a stock price of $75.32. All of these
numbers indicate the same outlook for Starbucks that reinforce our recommendation of
a buy.
We issue a​ BUY​ rating on Starbucks. We believe that the current market price does not
reflect the company’s increased commitment to global expansion and brand
development. Starbucks has room to grow in its primary US market and exciting
opportunities abroad particularly in the China/Asian Pacific Market. Starbucks has
shown a strong track record of economic growth and well­being and we predict this
trend to continue in the future.
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