A Cup of Good Coffee | Company Analysis: Starbucks Corporation (NASDAQ: SBUX)

Good stocks are like good coffee – not the easiest around to find, but the taste and aroma can be very rewarding, just like the returns and dividends. Starbucks is perhaps the most well-known coffee chain in the world, and it’s ubiquity in Singapore probably makes it the first choice for those who want to enjoy a cup of premium roasted coffee (or require free Wi-Fi and a place to study). Singapore alone has 107 Starbucks outlets, the 12^th highest in Asia, and probably one of the highest store counts per capita in the world. Which begs the question – is the stock as good as the coffee?

 

The Aroma of a Strong Cup of Growth

For once I shall not begin with analyzing price movements, but instead begin my analysis by highlighting the importance numbers. 

Impressively, Starbuck’s figures over the past five fiscal years are as strong as its coffee (if you order espresso, that is). Revenue growth is rock solid, growing in excess of 10% year-on-year for 5 consecutive years. Net profit follows suit, demonstrating equally strong growth, except the anomaly in 2013 due to litigation which I shall elaborate on later. Long term shareholders have been greatly rewarded in the process, with dividends continually growing year after year. 

The Raw Numbers
Fiscal Year	2011	2012	2013	2014	2015
Revenue*	11,700	13,300	14,890	16,440	19,150
Gross Profit*	2,160	2,590	3,180	3,820	4,560
EBITDA*	2,070	2,370	2,890	3,580	4,310
Net Profit*	1,250	1,380	8.30	2,070	2,760
Free Cash Flow*	1,080	894	1,760	(553)	2,450
Dividends paid*	389.5	513	628.9	783.1	926.6

*All figures in Millions of USD

The numbers speak for themselves. There really isn’t much to criticize here, except for the dip in free cash flow from 2011 to 2012. Looking at these raw numbers gives the impression that we have found a fantastic growth company to invest in, but we must be careful and look deeper.

Now, time to address the huge plunge in net profit in 2013, and negative free cash flow in 2014. Both of these were the result of a long legal dispute with Kraft, an American food company, which Starbucks ultimately lost. For that, it was ordered to pay Kraft US$2.8 Billion, resulting in a huge blow to its net profit. This huge but one-time negative cashflow was booked in fiscal year 2014, causing a big dent in its cashflow from operations, translating into negative free cash flow. 

However, if we do not factor in litigation charges from this (hopefully) one-off expense, net profit for FY2013 would have been $1.72 Billion, or $2.26 a share, while free cash flow would have been $2.21 Billion. This would have meant that net profit and free cash flow indeed have been growing continually for 5 consecutive years. To illustrate this incredible performance, I’ve plotted some of the data in two easy-to-read graphs. 

All figures in Millions of USD.

All figures in millions of USD.

One thing I’ll like to point out is Starbuck’s dividend policy, which I feel is well-tailored to both meeting shareholder demands, as well as retaining sufficient cold hard cash to fund expansion and day-to-day operating activities. Since it started paying dividends in 2010, Starbucks has an excellent track record of continually increasing dividends, growing dividend payouts by more than 20% every year. 

Per Share Data
Fiscal Year	2011	2012	2013	2014	2015
EPS*	0.83	0.92	0.01	1.38	1.84
DPS*	0.28	0.36	0.445	0.55	0.68

*Figures in USD

Starbucks looks set to be a lucrative pick for dividend investing, with solid dividend growth backed by increasing revenues and net profit, while maintaining a payout that is comfortably within its free cash flow. This also means there is more than sufficient headroom to maintain dividend payouts even should net profit and free cash flow take a hit. The company need not resort to borrowing or financial engineering to maintain a hefty dividend simply to please investors. Despite its current low dividend yield of about 1.5%, a long term dividend investor could see his dividend yield increase over time, assuming dividend growth continues.

Profitability and Managerial Effectiveness
Fiscal Year	2011	2012	2013	2014	2015
Gross Profit Margin	18.5%	19.5%	21.4%	23.2%	23.8%
Net Profit Margin	10.7%	17.8%	0.0557%	12.6%	14.4%
ROE	28.5%	27.0%	0.19%	39.3%	47.4%
ROA	17.0%	16.8%	0.72%	19.3%	22.2%

Profitability metrics paint a similar picture – generally widening profit margins and increased returns. This is a hallmark of strong and competent management. Likewise, we have to amend the numbers for 2013 to adjust for litigation charges. Net profit margin comes in at 11.6%, with return on equity (ROE) and return on assets (ROA) at 38.4% and 14.9% respectively – a drop from a year ago. However, both net profit margin and ROA appear to have recovered in the following two years. Once again, the figures are plotted in a graph for easy understanding. 

All figures in percentages.

Starbuck’s plans for growth show no sign of slowing down, as the company opens more stores around the world. In fiscal year 2015 alone, Starbucks added 1677 stores globally, a large majority of which in China and the Asia-Pacific region. No doubt, China and the Asia-Pacific region is now the number one destination for Starbucks to open its new stores, as the region’s coffee drinkers increase and demand for premium coffee swells.

 

The Flip Side: Lofty Expectations

So much said, if Starbucks is really such a stellar company, then its stock price must keep going up and up right? Not necessarily. With a track record of such stellar growth, the company has set the bar high for itself, and for the Wall Street analysts and their estimates.

To match these sky-high expectations for growth, Starbucks has to deliver time and again. Failure to meet a number could spell trouble for the stock, as Wall Street mercilessly sells it down. Just look back to July 2016, when quarterly results showed same store sales growth of 4% against expectations of 5.7%. Starbucks’ stock dropped by 4% immediately in response. Brutal. 

Currently trading at a price/earnings ratio of about 30, way above the P/E ratio of the S&P500 at 21, investors are clearly pricing in a lot of their expectations of growth into the stock and failure to meet those expectations would send the stock tumbling. Not meeting analyst expectations has been the main cause of the stock’s decline this year, with shares down by nearly 9%, while comparatively the S&P500 is up by nearly 8% so far. In fact, should the downtrend persist into the remaining two months of the year, Starbucks stock is poised to end the year in the red for the first time since 2011.

It’s the Charts, Again!

Looking at the three year chart, SBUX has had an incredible rally after breaking resistance at $40 in early 2015, rising by more than 50% to a high of about $62.50 by late 2015. Performance was less stellar in 2016, with the stock stuck in a downtrend. Prices are currently taking support in the vicinity of $52, the Feb 2016 low. A break below this level could see prices fall toward the psychological support level at $50, and a steepening of the current downtrend. 

However, without a near term catalyst, a sharp and sustained break downward below $50 is unlikely. Prices are likely to take cue from the next earnings report for FY2016, due on 3^rd November 2016, with prices likely to move sharply in either direction depending if analyst expectations are met.

The Final Word

To keep this post shorter (and therefore more readable), I have not gone into the specifics of revenue growth by region, nor analyzed liquidity or other performance ratios, nor done a cross comparison with competitor companies. That said, the raw numbers do paint a promising picture for Starbucks and the stock is worthy of an investment, but only if at the right price. 

While competition is intense in the industry, with Dunkin’ Doughnuts (in America) and McDonald’s encroaching on Starbucks’ regular customers, as well as small time coffee chains lurking in nearly every mall (as is the case in Singapore), Starbucks does somewhat have an economic moat in an industry with such low barriers to entry. For one thing, its brand name alone can justify the higher price charged to consumers, and is probably the buy-word for quality brewed coffee and other fancy beverages it comes up with.

Secondly, its long-standing relations with coffee suppliers as well as large scale of coffee purchases may result in better prices and/or savings. Also, Starbucks can effectively use derivatives to hedge against wild swings in coffee prices, something that small-time coffee outlets cannot do, or are unable to do so effectively due to their smaller scale of purchase. This provides Starbucks with some sort of financial shelter should coffee prices experience substantial.

Starbucks looks poised to continue to grow as it expands its business globally, especially in China where it now has more than 11,000 stores. It therefore makes a good investment for growth, while also benefiting from increasing dividends. 

However, current prices are a little too lofty and I would wait for cheaper valuations before making any investment. Investing in a well-known and closely-monitored company such as Starbucks, one would expect to be exposed to the ebbs and flows of market movements and corporate news, which could cause prolonged slumps in the stock. 

However, over a longer horizon, say 5 years, I trust that a company with such solid fundamentals would deliver market-beating returns, rewarding investors who have stuck by through thick and thin. Starbucks then, is not your next hot momentum stock, but one that rewards the patient long-term investor.

Just my two cents.