Starbucks: One of the most recognizable brands in the world.
Opdateret: 1. maj
Starbucks is the first choice for both U.S. and Chinese customers when they are having coffee away from home, while also being the leader in brand affinity, visitation, and frequency in these two large markets. Starbucks is also in top 30 in 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? It 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 don't own shares in Starbucks, and I never have. Personally, I prefer local coffee shops over Starbucks but like everyone else, I have obviously had my visits at Starbucks as well. Nevertheless, my preference towards local coffee shops will not affect my analysis on Starbucks, as I will stay unbiased. If you are interested in seeing or copying my portfolio, you can do so here.
Starbucks was founded in Seattle, USA in 1971 with a single shop. Now it has grown to the largest coffee chain in the world, and now operate 36.000 stores in more than 80 countries, serving more than 100 million customers daily around the world. 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 with 11 % of 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 royalty on retail sales. Licensees are responsible for operating costs and capital investments, which offsets the lower revenue that Starbucks receives. Starbucks is more than coffee shops, as they also have made a deal with Nestlé, granting Nestlé the rights to market Starbucks Consumer Packaged Goods and Foodservice products globally, which means that you, among other things, can buy Starbucks coffee beans on your local supermarket. 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 find a moat for Starbucks as they have a large brand moat, as consumers know and trust the brand.
Their CEO is Laxman Narasimhan. He joined Starbucks as executive officer-elect October 1, 2022, and took the role as CEO 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 through re-imagining some of Reckitt's most notable brands and doubling Reckitt's e-commerce business. He has also been credited for being able to adjust supply and production to meet the unprecedented high-demand for Reckitt's products during the Covid-19 pandemic, which shows that he could outperform expectations in one of the most complicated 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. He is also a member of the Board of Directors at Verizon. Laxman Narasimhan is highly thought of as a leader and when he announced his departure from Reckitt the shares fell 4 %. While we cannot judge Laxman Narasimhan yet, I feel comfortable with him leading Starbucks as he has nearly 30 years' experience in leading and advising global consumer-facing brands and is known for his operational expertise.
I believe that Starbucks has a strong brand moat. And I feel confident in Laxman Narasimhan being the right person to continue Starbuck's 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 investment capital, also known as ROIC. We want to see 10 years of history and we want the numbers to be above 10 % in all years, and ideally increasing from year to year. Starbucks has delivered some great numbers in the last 10 years. It is only in 2013 and during the pandemic in 2020 that Starbucks has underwhelmed. In all the other eight years, Starbucks has delivered a ROIC above 20 %, even in a challenging 2022. If I was to invest in Starbucks, I would feel good about these numbers.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. It is curious to see that Starbucks has a negative equity since 2019. The reason for that is that Starbucks has used debt to buy back shares. It might make sense if the stock is significantly undervalued, and the debt has a low interest rate. However, I personally like to see a company pay down debt, and I'm not sure that I like this strategy.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has left remaining after paying all of its financial obligations, I use the margin for it to make more sense. Free cash flow yield is the free cash flow per share a company is expected to earn against its market value per share. Starbucks has delivered a positive free cash flow in most years, even during the pandemic and a challenging 2022. Levered free cash flow margin has dropped in 2022 and is third the lowest we have seen in the last ten years, while the free cash flow yield indicates that Starbucks isn't cheap now, but we get back to that later in the analysis.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by earnings Doing the calculation on Starbucks, I can see that Starbucks has 4 years earnings in debt. It is a bit higher than I like, and I hope that Starbucks will refrain from taking on more debt to buy back shares.
Based on my findings so far, I believe that Starbucks is a good company. However, no investments are without risk and Starbucks has some risks as well. One risk that Starbucks mentions in their 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 where Starbucks profits went down 28 % and they had to close 900 stores. Thus, if we see a longer recession, it could affect Starbucks again. Wage inflation and unionization. We see a wage inflation around the world, and with higher wages comes higher operating costs. Hence, we have seen Starbuck's operating margin contracting from 19,8 % in fiscal 2021 to 14,6 % in fiscal 2022. If we see continued wage inflation, it will affect the profitability of Starbucks. Furthermore, Starbucks has an ongoing conflict with unions as thousands of employees decided to unionize for better pay and working conditions. It is hard to predict the outcome of this conflict but is something that needs to be monitored if investing in Starbucks. Finally, a strong dollar hurts profitability. Starbucks is generating approximately 2 % of their revenue from their international stores. It may not sound like much but as Starbucks report in U.S. dollars, a strong dollar will affect the results of Starbucks. In Q1 fiscal 2023, foreign currency translation had a 3 % impact on revenue. In the same quarter, Starbucks reported that revenue from international operations were down 10 % but if it wasn'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 to grow their business. One large catalyst is the potential growth in China. Starbucks has been in China for 25 years but according to management, they believe they are still in the early chapters of their growth story in China. Management believes that the new zero Covid policy in China will enable renewed consumer activity and will result in recovery in their business in the back half of fiscal 2023. In the short-term management expects a consumer activity in China will accelerate as we have seen in other countries post 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 have best in class return and profitability, if that pattern continues, China could be a large catalyst for Starbucks. Another growth potential is Starbucks rewards. Starbucks rewards is a reward program where customers can earn points that can be used for free drinks. Reward programs incentivize their customers to be more engaged with the brand, and results in increased customer visit frequencies. Starbucks rewards grows at a rapid pace and now have more than 30 million members. Starbucks mentioned that they continue to see increased customer engagement through the Starbucks reward, and if it can continue to grow by 15 % year over year as it did last year, it could be a great catalyst for Starbucks moving forward. Another catalyst is the Ready to drink segment. It is still a small part of Starbuck's revenue but over the last three years sales has grown by 19 % CAGR, and 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 margins than the other segments. Starbucks' overall operating margin was declining to 14,6 % in fiscal 2022 but the operating margin of the ready to drink segment 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 moving forward.
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 15 % is the highest I use), Estimated future PE 30 (which the double of the growth rate, as the historically PE for Starbucks has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY" 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 on 50 % so we will divide it by 2, meaning that we want to buy Starbucks at 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 was 1.941,3. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning 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 the Free Cash Flow Per Share at 2,18 and a growth rate of 15 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $34,40.
I believe that Starbucks is an interesting company, and I was very surprised about their high ROIC. We cannot judge management yet, but I feel confident that Starbucks 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 a lot of growth catalysts moving forward, where especially China could make up for the macroeconomic headwinds we see elsewhere in the world. If Starbucks succeed in keeping the reward program relevant, it could also lead to growth moving forward. I really like the ready to drink segment as well, but it is still just a small part of the revenue. My calculations are a bit conservative as I made them based on a challenging 2022. If I did the calculations based on the 2021 numbers, the highest price would be the PAYBACK TIME price at $60,46. Thus, I will be interested in Starbucks if it reached the 2021 PAYBACK TIME price at $60,46.
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