Starbucks is recommended as a buy based on its strong financial position and future growth prospects. Starbucks has shown increasing revenues, profit margins, and returns on equity in recent years. A discounted cash flow valuation estimates the stock's fair value at $70.94, above the current price. Starbucks maintains a loyal customer base and is well positioned to benefit from expanding internationally and introducing new products and services. While competition and commodity price fluctuations pose risks, Starbucks' brand strength and innovative strategies are expected to support continued profitable growth.

1. Starbucks Corporation
NASDAQ: SBUX
Sector: Consumer Spending
Industry: Coffee & Snack Shops
Stock Recommendation: BUY
Current Price: $62.57 (as of 10/30 2015)
Target Price: $70.94
Investment Motive
● Starbucks has recent released their quarter four revenues which showed a significant
increase of 18%, reaching a record high of $4.9 billion dollars. Their operating income
is also up 13% to a record of $969 million dollars.
● Starbucks has made plans to increase their presence internationally and will be
expanding its branches into Italy and will also offer alcoholic beverages in east
Loveland.
● Starbucks has future plans to expand its food selections and offerings. In the near
future 20-25% of stores will offer starbucks evening experiences which can potentially
increase their revenue by $1 billion dollars.
● The company plans to launch mobile order & pay and delivery services in the U.S.
● Starbucks maintains a loyal customer base and has a substantial following which
generates a stable and consistent revenue stream for the company.
Investment Risks
● As EL NIÑ O will continue through the winter and into the spring of 2016 at 95%, the
average prices of coffee and cocoa tend to increase in price by 5 to 10%. Indonesia, a
major producer of the lower-quality robusta variety, could experience drought in the
near future leading to a drop in output. African producers of coffee beans, may
experience heavy rains that could damage harvests in both Kenya and Uganda. These
drops in productivity by coffee suppliers can cause a shortage of premium coffee
beans for the next two years.
● Bloomberg has recently predicted a long-term shortage of coffee, this shortage will
drive the costs of coffee beans upwards and as a result will lead to higher prices in the
market as well as in Starbucks. In the short-term however, Starbucks will remain
relatively unaffected by the price fluctuations.
● Starbucks’ red cup controversy may impact their revenues since Republican
presidential candidate Donald Trump suggested that a boycott against the company.
Business Descriptions
Starbucks Corporation operates as a roaster, marketer, and retailer of specialty coffee
worldwide. The company operates in four segments: Americas; Europe, Middle East, and
Africa; China/Asia Pacific; and Channel Development. The company’s stores offer a product
mix of coffee and tea beverages, packaged roasted whole bean and ground coffees, single

2. serve products, juices and bottled water. Its stores also provide fresh food offerings, ready-to-
drink beverages, and various food products, as well as beverage-making equipment and
accessories. Starbucks has established more than 22,000 retail stores worldwide.
History and Founding
1971
Starbucks opens their first store in Seattle’s Pike Place Market.
1982
Howard Schultz joins Starbucks as the director of retail operations and marketing. Starbucks
begins providing coffee to fine restaurants and espresso bars.
1987
Il Giornale acquires Starbucks assets with the backing of local investors and changes its name
to Starbucks Corporation. Opens locations in Chicago and Vancouver, Canada.
1990
Starbucks expands their headquarters to Seattle.
1992
Completes initial public offering (IPO), offered shares of common shares at a price of $17 per
share.
2015
Announces sixth two-for-one stock split.
Total stores: 22,519 (as of June 28, 2015)
Industry Analysis
Over the past couple of years, the Coffee and Snack shops industry has been driven by
increasing consumer spending, higher disposable incomes and greater confidence in the
economic outlook. Demand for coffee and snack shops has also increased faster than most
segments of the food-service sector.
The industry has adapted to consumer preference over the past years, especially with regards
to health and diet. Consumers have become increasingly health conscious and have gone to
great lengths to avoid foods that are high in fat and salt content. Many operators selling
unhealthy foods have lost business to operators that promote more nutritious and healthy
options. The industry as a whole has become increasingly aware of this new trend and have
made providing healthier alternatives a priority.

3. Porter’s Five Forces
● Threat of new entrants: Moderate to low.
Cost of entry barrier into the market is not high enough to discourage new competitors.
Starbucks has an advantage over smaller localized shops because of the scope of their
operations and their financial status to provide a more competitive and attractive
pricing. Starbucks has a high percentage of the market share and has a lower cost of
operations and improved efficiency.
● Threat of substitutes: High.
There are many different substitute beverages to coffee, which consists of beverages
such as tea, fruit juice, etc. Potential customer base can also be impacted by home
produced coffee with coffee makers.
● Bargaining power of buyers: Low to Moderate.
Starbucks offers a wide variety of beverages to a large and diverse consumer base.
This diminishes the bargaining power of the buyers. Starbucks is able to price its
product in relation to its competitors with a competitive premium pricing.
● Bargaining power of Suppliers: Moderate.
The large scale of operations that Starbucks has allows them to take advantage of its
suppliers. Through forward vertical integration, the supplier in the industry poses a
low threat of competing against Starbucks. Due to Starbucks’ size and scope,
Starbucks forms a very influential relationship with suppliers and this gives Starbucks
more power and lowers the bargaining power of suppliers.
● Intensity of Competitors: High.
Starbucks has the largest market share and its next competitor also has a significant
portion of the market share. Consumers have a very low cost of switching to other
competitors, which intensifies competitive rivalry. Industry is mature and growth rate
is moderately low which causes competition to be moderately high due to competitors
trying to increase their own market share.
SWOT Analysis
Strength Threat

4. Global Retail Footprint
Wide geographical operations lead to greater
benefits, improved profit margins,
economies of scale, and recognition on a
worldwide basis. Starbucks had wide
presence enables the company to mitigate
risks associated with overdependence on a
specific market.
Comprehensive Offerings
Starbucks offers over 30 blends coffees.
Such comprehensive offerings helps the
company retain and capture existing and
new customer base.
Supply of High Quality Arabica Coffee Bean
The political and economic situation in many
of coffee regions, including Africa,
Indonesia, and Central and South America,
could become unstable, which in turn might
affect the company’s ability to buy coffee
from those parts.
Competition
Starbucks’ competitors for coffee beverage
sales include quick-service restaurants and
specialty coffee shops. The market is highly
competitive and with the entrance of more
new players, the level of competition is
expected to further intensify in the near
future.
Opportunity Weakness
Business Acquisition
The acquisition will allow the company to
accelerate growth across multiple channels
in the country, including the potential
introduction of new concepts, such as
Teavana.
Growth Markets: Asia-Pacific
Asia reported the most dynamic growth in
coffee consumption in the world, growing
by an average rate of 4% per annum,
increasing to 4.9% since the year 2000.
Product Recalls
Product recalls due to low quality and
misrepresentation not only affects the brand
image but causes the company incur
additional expenses.
Comparable Company Analysis

5. Comparable company analysis provided further support that Starbucks is in a good condition
at this time. The firm was compared with its competitor, Dunkin’ Donuts (DNKN).
Apparently, Starbucks got much more revenue and market capitalization than Dunkin’ Donuts
did. The Starbucks’ EV/FCF ratio of 40.73x was higher compared with Dunkin’ Donuts
(34.33x). The lower the ratio, the faster a company’s ability to pay back its cost of acquisition
or generating cash to reinvest in its business. The company’s P/E ratio was slightly higher
than the P/E ratio of Dunkin’ Donuts (29.39x). A high P/E suggests that investors expect
higher earnings growth in the future compared with those companies with a lower P/E.
Starbucks also has higher EV/EBITDA multiples than its competitor. A low ratio indicates
that a company is undervalued.
Valuation
Valuation is broken into four categories: discounted cash flows, WACC, sales growth, and
long-term growth rate.
● Discounted Cash Flow
A discounted cash flow model with a three-year horizon was used in stock price
projection. For calculating purposes, we first made some assumptions about sales
growth rate, terminal growth rate, discounted rate (WACC), shares outstanding and
net non-operating obligation (NNO). Secondly, we generated non-operating profit
after tax (NOPAT), net operating assets (NOA) from 2015 to 2018 by using each
year’s sale multiply net operating profit margin (NOPM) and net operating asset
turnover (NOAT). Finally, we can get free cash flows through NOPAT minus increase
in NOA in each year.

6. After obtaining each year’s free cash flows, we discounted those with WACC to get
present value of free cash flows. Summing up those present values, we can get the
value of firm in 2015. In the end, we deducted NNO from value of firm to get equity
value, and then divided by shares outstanding in 2015 to get our target price: 70.94.
● WACC
Our WACC in 2014 is 6.17% and 5.94% in 2015. We used following equation to get
our cost of equity and used weighted average cost of debt from 10-K as our cost of
debt to get out WACC.
In the future, we expect our WACC is going down because of higher and higher sale
growths that make cost of equity lower.
● Sales Growth
After Starbucks quarter four conference call, we replaced our sales growth rate to
16.51% in 2015 and took average sales growth rate of 13.04% as future sales growth
rate during 2016 to 2018. The reason is that the coffee& snack shops industry growth
rate is 2.7% from 2017 to 2020, and the average Starbucks growth rate is slightly
above double two digits (around 13%). Since the economic shows a recovery in 2015
so that we saw Starbucks has a strong sales growth of 16.51% in 2015 when we added
Q4 revenue into our income statement. In the following years, we assumed a growth
rate of 13.04% as the future projection. Based on Starbucks five-year plan which will
accelerate its revenues by Starbucks Evening event and new mobile order, we are
optimistic to Starbucks revenues compared with Yahoo analyst’s estimation of 8.5%
for 2016.
Long-term growth

7. Consumer spending, healthy eating index, per capita coffee consumption and
consumer confidence index are key elements of coffee and snacks industry. Starbucks
always satisfies customers and customizes their products for its customers. In the
long-term, it’ll still lead consumers to the new era by innovating dynamic ways across
coffee, tea and retail, unlock new markets and keep involved in digital and mobiles
technologies.
In food program, Starbucks expects continued top and bottom-line growth in its food
platform as it elevates and expands its offering of savory, locally relevant food
offerings around the world. Starbucks announced plans to double its U.S. food
revenue to over $4 billion over the next five years. By offering Starbucks Evening,
which features a thoughtful selection of wine and craft beer alongside the signature
coffee and tea beverages. Till 2019, the company plans to have 20%-25% stores in the
U.S. that offer Starbucks Evening experience.
● Conclusion
Despite increased dynamic competition, Starbucks is expected to continue to produce
strong free cash flow. The company’s leading position in the industry will allow it to
maintain sufficient revenues and margins to provide positive returns to investors.
Besides, the company’s innovative ways across coffee, tea, customer convenience and
mobile payment could generate considerable future revenues, ushering a new era for
all-rounded future growth management.
Sensitivity Analysis
We used 2015 WACC as our discount rate and set 2.8% as our terminal rate, which we get the
stock price $70.94.($70.98 on the table is because the different digits we used after the
decimal point.) The discount rate is the WACC in our valuation using weighted average cost
of debt and cost of equity; we set terminal rate as 2.8% since the industry long-term growth is
2.7% and Starbucks is the global market leader in this industry and doing much better than the
industry. The table shows the variable results after using different discount rates and terminal
rates, indicating the best and worst scenarios in Starbucks stock price and showing that
Starbucks is a high growth stock.

8. Financial Analysis
Revenue Growth
The company shows a sustainable growing prospect in sales, and it’s revenues growth rate is
13.47% from 2011 to 2012, 11.98% from 2012 to 2013 and 10.63% from 2013 to 2014.
Although the growth rate slightly declined during 2011 to 2014, Starbucks bounced back in
2015 and achieved a 16.51% sales growth rate. In the future, we still anticipated a double
digit growth rate of 13.04% because of it’s strategy for expanding branches and diversifying
it’s products.
Dupont analysis
ROE=PM*Asset turnover*EM
We can see an increasing ROE from 2013 to 2015. The ROE in 2013 is so low is because of
litigation charge. (Starbucks Kraft Lawsuit: Coffee Chain Must Pay $2.76 Billion To Settle
Dispute). After 2014, ROE got back to 40% and increased to 48.65%, which related to a
higher Profit margin.
Profit margin=Net income/Sales. Creating a common size I/S to compare the percentage of
sales in Net income, we noticed a greater NI/ sales of 14.4% in 2015. Therefore, we have
greater PM and ROE.

9. Decision Summary
(1-year stock price)

10. We recommend a ‘BUY’ on Starbucks stock. Starbucks’ long-term growth prospects are
bullish due to strong earnings estimates and stable cash flows. Starbucks customizes their
beverages based on the client's’ preferences and offers a wide variety of options that keep
customers loyal and helps to bring in new customers. Starbucks’ strong financial position,
well marketed brand name, and continuous desire to improve their quality and service have
made Starbucks a global market leader and a dominant force in the coffee and snack shop
industry. In addition, Starbucks bought 1.48 million shares in 2014, expecting in its long-term
potential growth. In the valuation model, we calculated the target price to be $70.94, which is
higher than the current stock price $62.57. This shows that the current stock price is
undervalued. As an upward historical stock price graph presents, we anticipate a stock rally in
the future. All in all, we recommend a ‘BUY’ on Starbucks stock.
Sources
1. http://finance.yahoo.com/q?s=sbux&fr=uh3_finance_web&uhb=uhb2
2. http://www.starbucks.com/

11. 3. Has Coffee Finally Caught A Break? (DNKN,JO,SBUX,SJM)
http://www.investopedia.com/articles/investing/100815/has-coffee-finally-caught-
break.asp#ixzz3q5An8Ry0
4. http://www.bloomberg.com/research/stocks/snapshot/snapshot.asp?ticker=SBUX
5. http://www.cheatsheet.com/business/4-reasons-starbucks-is-a-compelling-
investment.html/?a=viewall
6. http://clients1.ibisworld.com/reports/us/industry/default.aspx?entid=1973
7. http://scholar.harvard.edu/files/nithingeereddy/files/starbucks_case_analysis.pdf
8. Global Data
9. Capital IQ
10. Fidelity
11. http://www.investopedia.com/
12. Bloomberg terminal
13. https://news.starbucks.com/news/starbucks-details-five-year-plan-to-accelerate-
profitable-growth
14. http://www.usatoday.com/story/money/nation-now/2015/11/11/itsjustacup-mocks-
starbucks-red-cup-controversy/75563876/