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  • Glenn

Starbucks: One of the most recognizable brands in the world.

Opdateret: 30. okt.

Starbucks is the top choice for both U.S. and Chinese customers when they want to have coffee outside of their homes. It is also the leader in brand loyalty, customer visits, and frequency of visits in these two major markets. Starbucks is also in the top 30 of the most valuable brands in the world. I like companies with a strong brand, but does it mean that now is the 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 remainunbiased. 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 very user-friendly and easy to get started with. You can start with as little as $50. Click on the picture below to get started.

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 (51% of all stores in 2022) and licensed stores (49% of all stores in 2022). Starbucks generated 82% of their revenue in 2022 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 buy Starbucks coffee beans at your local supermarket, among other things. 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,as they have built a powerful brand moat, as consumers know and trust the brand.

Their CEO is Laxman Narasimhan. He joined Starbucks as the executive officer-elect on October 1, 2022, and assumedthe role of CEO on March 20, 2023. Prior to joining Starbucks, he was the CEO of Reckitt, which he led through a major transformation and a return 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 in 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. He has nearly 30 years of experience in leading and advising global consumer-facing brands and is known for his operational expertise.

II believe that Starbucks has a strong brand moat. And I feel confident that Laxman Narasimhan is the right person to continue Starbucks' growth. Now let us investigate the numbers to see if Starbucks does live up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.

The first number we will look into is the return on invested capital, also known as ROIC. We want to see 10 years of history, with all the numbers ideally above 10% in each year and ideally increasing from year to year. Starbucks has delivered some great numbers in the last 10 years. It was only in 2013 and during the pandemic in 2020 that Starbucks underwhelmed. In all the other eight years, Starbucks has achieved a ROIC above 20%, even in the challenging year of2022. If I were to invest in Starbucks, I would feel good about these numbers.

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 actualnumbers and the percentage growth year over year. It is curious to see that Starbucks has a negative equity since 2019.The reason for this is that Starbucks has utilized debt to repurchase shares. It might make sense if the stock is significantly undervalued and the debt has a low interest rate. However, I personally prefer to see a company reduce its debt, and I'm uncertain about my opinion on this strategy.

Finally, we will investigate the free cash flow. In short, free cash flow refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use the margin to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. Starbucks has consistently generated positive free cash flow in most years, including during the pandemic and a challenging 2022. The levered free cash flow margin has dropped in 2022 and is the third lowest we have seen in the last ten years. Meanwhile, the free cash flow yield indicates that Starbucks is not currently cheap, but we will discuss this further in the analysis.

Another important aspect to investigate is the level of debt, specifically whether a business has a manageable debt that can be paid off within a period of 3 years. We do this by dividing the total long-term debt by earnings. After performing the calculation on Starbucks, I can see that Starbucks has 4 years' worth of earnings in debt. It is a bit higher than I would prefer, and I hope that Starbucks will avoid acquiring additional debt in order to repurchase shares.

Based on my findings thus 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 economic slowdown.They mention that a continued economic slowdown or recession 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 is back in 2008, when Starbucks' profits went down by 28% and they had to close 900 stores. Thus, if we experience a prolonged recession, it could once again impact Starbucks. Wage inflation and unionization. We are witnessing wage inflation worldwide, and this increase in wages leads to higher operating costs. Hence, we have seen Starbucks' operating margin contracting from 19,8% in fiscal 2021 to 14,6% in fiscal 2022. If we continue to see wage inflation, it will impact the profitability of Starbucks. Furthermore, Starbucks has an ongoing conflict with unions, as thousands of employees have decided to unionize in order to improve their pay and working conditions. It is difficult to predict the outcome of this conflict, but it is something that needs to be monitored if investing in Starbucks. Finally, a strong dollar hurts profitability. Starbucks is generating approximately 2% of its revenue from its international stores. It may not sound like much, but since Starbucks reports in U.S. dollars, a strong dollar will impact the company's results. In Q1 fiscal 2023, foreign currency translation had a 3% impact on revenue. In the same quarter, Starbucks reported that revenue from international operations was down 10%, but if it weren't for foreign currency translation, revenue would have been up 2%. Management expects that foreign currency translation will affect revenue and earnings growth by 3% in fiscal 2023.

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 believes that China's new zero-Covid policy will stimulate consumer activity and lead to a business recovery in the second half of fiscal 2023. In the short term, management expects consumer activity in China to accelerate, as we have seen in other countries after Covid lockdowns. In the long term, Starbucks expects to grow their current 6.100 stores in China to 9.000 stores by 2025. Interestingly, management mentioned that their newest class of stores has best-in-class return and profitability. If that pattern continues, China could be a significant catalyst for Starbucks. 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 at a rapid pace and now has more than 30 million members. Starbucks mentioned that they continue to see increased customer engagement through the Starbucks Rewards program. If this growth continues at a rate of 15% year over year, as it did last year, it could serve as a significant catalyst for Starbucks' future success. Another catalyst is the ready-to-drink segment. It is still a small part of Starbucks' revenue, but over the last three years,sales have grown by 19% CAGR. Management believes that the segment is far from reaching its potential. What is interesting about the ready-to-drink segment is that it has much higher profit margins compared to the other segments.Starbucks' overall operating margin declined to 14,6% in fiscal 2022, but the operating margin of the ready-to-drinksegment increased by 3,5% to 47,4%, which is significantly higher than the overall operating margin. If Starbucks can continue to grow this segment, it will lead to higher profitability in the future.

All right, we have gone through the numbers, potential and risk regarding Starbucks, and now it is time for us to calculate a price for Starbucks. In order to calculate price, we will need the numbers that I have explained in the "MY STRATEGY" section of the website, as I do not want to go through the whole calculation here. I chose to use an EPS of 2,83, which is the one from fiscal 2022. I chose an estimated future EPS growth rate of 15% (management's long-term target is 15-20%, but I am using 15% as the highest value). I also selected an estimated future PE of 30 (which is double the growth rate, as the historical PE for Starbucks has been higher). Additionally, we have already established a minimum acceptable return rate of 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $84,90, and we want to have a margin of safety of 50%. So, we will divide it by 2, meaning that we want to buy Starbucks at a price of $42,45 (or lower obviously), if we use the Margin of Safety price.

Our second way to calculate a buy price is the Ten Cap price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The operating cash flow last year was 4.119,6 The capital expenditures were 1.941,3. I tried to look through their annualreport to see how much of the capital expenditures were used for maintenance. I couldn't find it, so as a rule of thumb, you can expect 70% of the capital expenditures to be used on maintenance. This means that we will use 1.358,9 in our further calculations. The tax provision was 982. We have 1.148,5 outstanding shares. Hence, the calculation will be like this: (4.119,6 - 1.358,9 + 982) / 1.148,5 x 10 = $32,59 in Ten Cap price.

The last calculation is the Payback Time. I also described in "MY STRATEGY". With Starbucks' Free Cash Flow Per Share at 2,18 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is $34,40.

I believe that Starbucks is an intriguing company, and I was pleasantly surprised by their high ROIC (Return on Invested Capital). We cannot judge management yet, but I feel confident that Starbucks has found the right person to drive future growth. Starbucks is facing some short-term headwinds regarding a strong dollar, the macroeconomic outlook, and wage inflation, while we don't know what will happen with their unionization problems. Starbucks has numerous growth catalysts moving forward, particularly in China, which could offset the macroeconomic headwinds experienced in other parts of the world. If Starbucks succeeds in keeping the reward program relevant, it could also lead to future growth. I really like the ready-to-drink segment as well, but it still only contributes a small portion of the revenue. My calculations are a bit conservative as I made them based on a challenging 2022. If I calculate based on the 2021 numbers, the highest price would be the Payback Time price of $60,46. Thus, I will be interested in Starbucks if it reaches the 2021 Payback Time price of $60,46.

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