Market Cap (USD Mil) 56,715
52-Week High (USD) 82.50
52-Week Low (USD) 52.52
52-Week Total Return % 36.8
YTD Total Return % -4.0
Last Fiscal Year End 30 Sep 2013
5-Yr Forward Revenue CAGR % 11.6
5-Yr Forward EPS CAGR % 238.6
Price/Fair Value 0.96
2012 2013 2014(E) 2015(E)
Price/Earnings 28.3 NM 28.1 24.0
EV/EBITDA 15.4 19.6 16.4 14.1
EV/EBIT 20.4 25.4 20.3 17.2
Free Cash Flow Yield % 2.3 3.0 -3.3 2.8
Dividend Yield % 1.4 1.1 1.3 1.9
2012 2013 2014(E) 2015(E)
Revenue 13,300 14,892 16,538 18,540
Revenue YoY % 13.7 12.0 11.1 12.1
EBIT 1,787 2,207 2,810 3,323
EBIT YoY % 17.2 23.5 27.3 18.3
Net Income, Adjusted 1,385 8 2,042 2,384
Net Income YoY % 11.1 -99.4 24,506.6 16.7
Diluted EPS 1.79 0.01 2.67 3.12
Diluted EPS YoY % 10.7 -99.4 24,429.3 16.9
Free Cash Flow 497 980 -2,004 1,453
Free Cash Flow YoY % 83.4 97.2 -304.4 -172.5
Starbucks is well positioned to leverage its brands into a global multichannel growth story.
R.J. Hottovy, CFA Director
rj.hottovy@morningstar.com +1 (312) 244-7060
Research as of 29 Jan 2014 Estimates as of 28 Jan 2014 Pricing data through 14 Feb 2014 Rating updated as of 14 Feb 2014
Investment Thesis 23 Jan 2014
We view Starbucks as one of the most compelling growth stories in the consumer space today, well positioned for top-line growth and margin expansion through product innovations, meaningful cost advantages, and its evolution into a diversified retail and consumer packaged goods platform. Representing about one third of coffee cups sold at retail, and 4% of the 90 billion coffee cups brewed at home in the U.S., Starbucks still has meaningful domestic growth potential, including new beverage innovations and a revamped food platform, expanded peak hour capacity, and My Starbucks Rewards usage. At a time when most restaurant and retailers are struggling to stimulate transaction growth, Starbucks' recent transaction gains are impressive and underpin the global strength of its brand. We also believe operational best practices from Starbucks' U.S. stores can be applied to retail locations in Europe and Asia, driving future unit-level productivity improvements.
Starbucks is also much more than retail expansion story, and we believe the company is just starting to scratch the surface of its longer-term channel development, brand diversification, and geographic expansion opportunities. We believe many of the competitive advantages of Starbucks' core retail operations will extend into these diversification efforts, putting the company in a unique position to capture retail and wholesale market share over a long horizon. Platforms like VIA single-serve coffee, K-Cups, Verismo, and Seattle's Best Coffee should support channel diversification efforts over the near term, with nascent brands like Evolution Fresh, La Boulange, and Teavana becoming important cash flow contributors over a longer horizon. We're also optimistic about potential mobile, digital, and loyalty program synergies across its different business lines. Starbucks' international growth potential is undeniable, particularly in emerging markets like China, India, and Brazil. Formidable threats exist in both the retail and wholesale channels, but we believe a wide moat founded on strong brand equity, bargaining clout with its suppliers, and a highly leverageable model will be enough to stave off rivals.
Through a global chain of more than 20,000 company-owned and licensed stores, Starbucks sells coffee, espresso, teas, cold blended beverages, food, and accessories. In addition to its retail operations, the firm distributes packaged coffee, VIA single-serve, K-Cup, Verismo, and tea products through its own stores as well as grocery stores, and warehouse clubs under the Starbucks, Tazo, and the Seattle's Best Coffee brands. Starbucks also markets bottled beverages, ice creams, and liqueurs through various partnerships.
Profile Vital Statistics
Valuation Summary and Forecasts
Financial Summary and Forecasts
The primary analyst covering this company does not own its stock.
Currency amounts expressed with "$" are in U.S. dollars (USD) unless otherwise denoted.
Historical/forecast data sources are Morningstar Estimates and may reflect adjustments.
Analyst Note: Results prior to Fiscal 2009 have not been recast for 2012 organizational structure changes and indirect overhead cost accounting.
(USD Mil)
Contents
Investment Thesis Morningstar Analysis
Analyst Note
Valuation, Growth and Profitability Scenario Analysis
Economic Moat Moat Trend Bulls Say/Bears Say Credit Analysis
Financial Health Capital Structure Enterprise Risk Management & Ownership Analyst Note Archive Additional Information Morningstar Analyst Forecasts Comparable Company Analysis Methodology for Valuing Companies
Fiscal Year:
Fiscal Year:
1
- 2 2 3 4 5
6 6 7 8 9 - 12 16 18
Morningstar Analysis
Valuation, Growth and Profitability 29 Jan 2014 Our fair value estimate is $78 per share, which implies fiscal 2015 fiscal-year price/earnings of 25 times, an enterprise value/EBITDA of 14 times, and a free cash flow yield of 2.3%. Shares may appear lofty at 28 times the midpoint of management's fiscal 2014 EPS target, but we believe a premium valuation is justified given the firm's compelling growth and margin expansion story among large-cap consumer stocks.
Despite an uncertain macro and consumer spending backdrop, we view management's 2014 guidance as realistic (if not slightly conservative), including top-line growth of at least 10%, mid-single-digit comparable-store sales growth, 1,500 net new stores (representing 8% unit growth), 150-200 basis points of operating margin expansion (putting full-year operating margins between 18%-18.5%), and earnings per share of $2.59-$2.67. We forecast 11% top-line growth, driven by 4% consolidated comparable-sales growth (including 5% comps in the Americas, 4% comps in EMEA, and 7% comps in China/Asia-Pacific), 1,500 net new locations globally (9%
unit growth), and low- to mid-teens growth in the channel development segment. Our comp assumption is based largely on traffic gains as well as a modest increase in the average transaction size due to new in-store food and packaged good offerings. During the next 10 years, we anticipate average annual revenue growth in the low double-digit range, driven by new sales channels and geographies for single-serve platforms and licensing agreements. Our model assumes 1,400-1,500 annual net new store openings over the next decade (including nascent brands), putting Starbucks on track to expand its global store base to almost 34,500 locations by the end of fiscal 2023 (implying 6% annual organic unit growth).
Starbucks' recent profitability gains demonstrate the highly leverageable nature of its business model. Operating margins have improved because of unproductive store
closings, support staff/infrastructure reductions, in-store operational improvements, and supply chain efficiencies.
Our model calls for more than 200 basis points of operating margin expansion (implying fiscal 2014 operating margins of approximately just north of 18.5%), driven by operating leverage and channel development segment margin improvement. Longer term, we believe operating margins in the low-to-mid 20% range are achievable through increased penetration of profit-accretive retail and wholesale initiatives and licensing arrangements.
Scenario Analysis
We expect growth from Starbucks' international operations (EMEA and China/Asia-Pacific) and channel development segment to outpace domestic growth rates over the next several years. Growth rate assumptions for these segments are the key variables in our discounted cash-flow valuation.
Our base-case model assumes that the EMEA, China/Asia-Pacific, and channel development segments grow revenue at average annual rates of 12%, 22%, and 14%, respectively, over the next decade, compared with expectations of 9% growth in the Americas region.
If Starbucks' progress in EMEA and China/Asia-Pacific were to slow to 9% and 20%, respectively, and consumer products group segment growth were to come in closer to 10% amid competitive countermeasures from major CPG firms, we would expect consolidated operating margins to peak around 21% longer term (compared with 25% in our base-case assumptions). Under this scenario, our fair value estimate would be approximately $53 per share.
Conversely, if Starbucks were to sustain 15% growth in the EMEA region, 25% growth in China/Asia-Pacific, and 20%
growth in the channel development segment over the next decade, we would expect average operating margins to eventually reach the 28% range. If these assumptions were to play out, our fair value estimate would be roughly $112 per share.
Economic Moat
Nonexistent switching costs, intense industry competition, and low barriers to entry make it extremely difficult for restaurants and specialty retailers to establish durable competitive advantages, but with a wide economic moat based on meaningful scale advantages and a brand intangible asset that commands premium pricing, we expect Starbucks will maintain its specialty coffee leadership. Our confidence is supported by Starbucks' channel development efforts (VIA, K-Cups, and Verismo), emerging-market expansion opportunities (namely China, India, and Brazil), and its complementary brand portfolio (Evolution Fresh, La Boulange, and Teavana), which provide visibility for low- to mid-teens average revenue growth and at least high-teens cash flow growth over the next decade. Although there are certainly execution and brand saturation risks tied to management's loaded agenda, we believe Starbucks' initiatives, if executed properly, could fortify its already wide economic moat.
With almost 11,500 company-owned and licensed locations in the U.S., Starbucks maintains a sizable lead over direct
domestic rivals, including Dunkin' Donuts (6,800 U.S. points of distribution), Caribou Coffee (600), and Peet's Coffee (200) (the latter two chains are now owned by the Joh. A.
Benckiser Group). With cafe-like environments and a brand that invokes a high-quality customer experience, Starbucks enjoys pricing power advantages over most specialty coffee peers. New product platforms such as smoothies and tea as well as a revamped food program have added diversity to the menu, allowing the firm to broaden its target audience and expand daypart penetration. We also believe Starbucks wields considerable influence over arabica coffee bean suppliers, ensuring access to raw materials at competitive prices. In addition, retail landlords often grant exclusive leases to prominent locations rife with consumer traffic, which we believe could accelerate the global growth aspirations of Starbucks' more nascent retail concepts over the next decade and make it more difficult for rivals to compete.
Many of Starbucks' competitive advantages also apply to international markets, which we view as a critical growth engine over the next several decades. With a widely recognized brand, Starbucks is among the few retail concepts to be successfully replicated across the globe. As such, we believe the firm will eventually exceed its domestic store count overseas. The chain has more than 8,300 units outside the U.S. in 60 countries, including some well-established cafe cultures. Emerging-market prospects are also intriguing, including opportunities in markets such as China (which already has more than 1,100 units, on its way to 1,500 by 2015, and 4,000-5,000 over a longer horizon), as well as Brazil and India (which offer potential for at least a thousand units apiece over the next decade, in our view).
Starbucks' channel development aspirations also underscore the power of its brand intangible asset. We view the company as one of the few food-service operators that could evolve into a world-class consumer packaged goods
company due to its ability to connect with grocery and mass-channel customers through licensed on-premise stores. With already strong bargaining clout with national retailers like Costco, Kroger, Whole Foods, and Trader Joe's, we expect Starbucks to develop national distribution of its entire consumer product portfolio over the next several years. With consumer packaged goods penetration in more than 20 countries (which has doubled the past two years), Starbucks should also have ample opportunities to expand its presence on grocery and mass-channel shelves across the globe. We've also been impressed by Starbucks' efforts to expand its distribution beyond traditional outlets, including other restaurant chains, hotel customers, and airlines.
Continued market share gains in the $8 billion-plus premium single-serve coffee category (where the company now exceeds $300 million in VIA system sales and controls a high-teen percentage of the K-Cup market) will likely be the key driver for the channel development segment. However, with Starbucks Refreshers energy drinks, the Verismo at-home brewing system (and ancillary coffee and milk pods), and the long-term potential of new food, juice, and tea products stemming from La Boulange, Evolution Fresh, and Teavana, respectively, we remain comfortable with a mid- to high-teens average annual revenue growth forecast for the channel development and other segments from fiscal 2014-18, especially considering the premium single-serve distribution infrastructure already in place. More important, we anticipate that the channel development segment will become an increasingly important free cash flow contributor. Even with the marketing and labor costs necessary to support new product launches, we anticipate that this segment will start to see meaningful margin expansion in fiscal 2014, with full-year segment margins somewhere near 33% and north of 40% over the next decade.
Moat Trend
Although the compelling economics of a specialty coffee program have attracted a host of substitutes in recent years, we believe Starbucks' moat trend is stable. We believe Starbucks has effectively neutralized some emergent competitive threats by partnering with leading quick-service restaurant chains to offer Seattle's Best Coffee, including Subway and Burger King. Additionally, we still believe that few national/regional restaurant or specialty coffee operators are willing or able to compete with Starbucks' in-store customer experience, outside a handful of fast-casual concepts like Panera.
In our view, Starbucks' decision to expand past its traditional retail roots and develop a more substantive consumer packaged goods business also has a high probability of success given a well-recognized brand name that commands premium pricing and unique ability to connect with grocery and mass-channel customers through its licensed on-premise stores. Although this decision likely will require incremental supply chain and distribution costs over the next few years, we're convinced that having greater control of its own consumer product distribution ultimately will strengthen the company's competitive position, driving excess economic returns over the long haul.
Bulls Say/Bears Say
Bulls Say Bears Say
3A three-pronged approach (VIA, K-Cups, Verismo) should lead to market share gains in the $8 billion higher-margin premium single-cup coffee category.
3A reinvigorated food menu, La Boulange pastry products, store redesigns, increased usage of social media tools, and the My Starbucks Rewards program have improved the Starbucks customer experience, penetrated new dayparts, and boosted unit-level productivity.
3Despite its growth plans, we believe Starbucks can sustain a 40%-45% dividend payout ratio, implying at least high-teens dividend growth over the next decade.
3Because switching costs are minimal, there is little to prevent customers from trading to other specialty coffee chains including Dunkin' Brands, Tim Hortons, or McDonald's. Joh. A. Benckiser Group's consolidation of Peet's, Caribou Coffee, and D.E Master Blenders could evolve into a formidable specialty coffee rival.
3Nascent brands such as Evolution Fresh, La Boulange, and Teavana could take attention from the core Starbucks brand and add execution risk to management's already loaded agenda.
3Volatile labor costs and commodity prices could weigh on quarter-to-quarter operating results.
2014(E) 2015(E) 2016(E) 2017(E) 2018(E)
Cash and Equivalents (beginning of period) 2,576 233 191 374 744
Adjusted Available Cash Flow -1,911 1,247 1,601 1,881 2,259
Total Cash Available before Debt Service 665 1,480 1,792 2,255 3,003
Principal Payments — — -400 -550 —
Interest Payments -58 -63 -63 -55 -55
Other Cash Obligations and Commitments -963 -1,010 -1,088 -1,137 -1,201 Total Cash Obligations and Commitments -1,021 -1,073 -1,551 -1,742 -1,256
USD Millions
% of Commitments
Beginning Cash Balance 2,576 38.8
Sum of 5-Year Adjusted Free Cash Flow 5,077 76.4
Sum of Cash and 5-Year Cash Generation 7,653 115.2
Revolver Availability 1,000 15.1
Asset Adjusted Borrowings (Repayment) — —
Sum of Cash, 5-Year Cash Generation, Revolver and Adjustments 8,653 130.2
Sum of 5-Year Cash Commitments -6,644 —
SBUX Sector Universe
Business Risk 4 5.4 5.1
Cash Flow Cushion 7 5.8 6.1
Solvency Score 5 5.4 5.0
Distance to Default 1 4.1 3.9
Credit Rating A- BBB BBB+
Five Year Adjusted Cash Flow Forecast (USD Mil)
Credit Analysis
Cumulative Annual Cash Flow Cushion
Cash Flow Cushion Possible Liquidity Need
Adjusted Cash Flow Summary
Credit Rating Pillars Peer Group Comparison
Source: Morningstar Estimates
Note: Scoring is on a scale 1-10, 1 being Best, 10 being Worst
Financial Health & Capital Structure
With a consistent record of positive free cash flow, manageable debt maturities over the next five years, and leverageable assets on the balance sheet, we believe Starbucks is in sound financial health. Following recent debt issuances, debt/capital stands around 28%, EBITDA covers estimated interest expense by more than 75 times, and the Cash Flow Cushion (cash on the balance sheet and future cash flow divided by debt and debt-like obligations) is about 1.1 times. We grant Starbucks an issuer credit rating of A-, implying low default risk.
The company recently added $1.5 billion of leverage to its capital structure, including $750 billion of 3.85% senior notes due October 2023 (priced in September 2013), $400 million of 0.875% senior notes due 2016, and $350 million of 2.0% Senior Notes due 2018 (the latter two offerings were priced in December 2013). Proceeds from the December 2013 transaction will be partially used to fund a portion of the payment required by the arbitration award required as part of Starbucks' 2010 decision to end its packaged-coffee distribution arrangement with Mondelez (citing poor management of the Starbucks brand in the grocery store channel) and Mondelez's subsequent rejection of Starbucks' $750 million offer to terminate the relationship. The only other long-term debt on Starbucks' balance sheet is $550 million in 6.25% senior notes due in August 2017, and the company has almost $2.5 billion in borrowing capacity under its revolving credit facility and commercial paper programs, which includes a $750 million unsecured credit facility that allows Starbucks to increase the commitment amount by an additional $750 million, and
$1 billion in commercial paper commitments.
Debt/capital and total debt/EBITDA have averaged 14% and 30% during the last three years, respectively, though we expect these metrics to gradually improve from current levels of 28% and 55% in the years to come. Free cash flow
Credit Analysis
has averaged about 9% of revenue the last three years (including $1.8 billion in fiscal 2013) and we anticipate similar levels over the next several years (excluding the aforementioned litigation payments scheduled to take place in fiscal 2014), suggesting that Starbucks should have little trouble supporting debt obligations, dividend payments, or future share buyback activity. Additionally, the firm had $3.2 billion in net property, plant, and equipment as of September 2013, which should provide an asset base to secure debt if necessary. Even with a target dividend payout range of 35%-40% of net income, we find few reasons to believe that Starbucks will be forced to access capital markets on unfavorable terms over the next several years.
Enterprise Risk
We assign a medium uncertainty rating to Starbucks. The company faces increased competition on several fronts, including a resurgent Dunkin' Brands; the consolidation of Peet's, Caribou Coffee, and D.E Master Blenders under the Joh. A. Benckiser Group portfolio; and an influx of specialty coffee programs at quick-service and fast-casual restaurant chains. Given its position as a more affluent consumer brand, discretionary spending headwinds could periodically dampen top-line results. Coffee commodity costs can affect profitability, as well as labor and occupancy cost inflation.
Starbucks faces heightened economic, legal, and political risk associated with its international expansion efforts. The company has also taken on multiple layers of execution risk (including the further development of K-Cups and Verismo and the integration of Evolution Fresh, La Boulange, and Teavana).
Name Position Shares Held Report Date* InsiderActivity
MR. JOHN CULVER President, Divisional 123,317 12 Dec 2013 20,000
MR. CLIFFORD BURROWS President, Divisional 102,006 25 Nov 2013 35,000
TROY ALSTEAD CFO/Chief Accounting Officer/
President, Divisional 100,545 25 Nov 2013 114,807
MR. JEFFERY J.
HANSBERRY
President, Divisional 81,732 14 Nov 2013 —
LUCY LEE HELM Executive VP/General Counsel/
Secretary 55,950 10 Dec 2013 12,500
Top Owners % of Shares
Held % of Fund Assets Change
(k) Portfolio Date
Fidelity Contrafund Fund 2.15 1.15 522 31 Dec 2013
Vanguard Total Stock Mkt Idx 1.41 0.27 153 31 Dec 2013
T. Rowe Price Growth Stock Fund 1.21 1.73 — 31 Dec 2013
PowerShares QQQ Trust, Series 1 1.13 1.36 18 13 Feb 2014
Vanguard Institutional Index Fund 0.98 0.36 6 31 Dec 2013
Concentrated Holders
Fidelity Select Leisure Portfolio 0.15 14.88 33 31 Dec 2013
KIM Luxury Equity 1 — 5.78 — 30 Sep 2013
Polen Growth Fund 0.03 5.56 -10 31 Dec 2013
Helios Equity Dynamic — 5.23 13 31 Dec 2012
NW Global Strategy — 4.83 — 31 Jan 2014
Top 5 Buyers % of Shares
Held % of Fund Assets
Shares Bought/
Sold (k) Portfolio Date
Fidelity Management and Research Company 6.34 0.60 4,200 30 Sep 2013
Winslow Capital Management, LLC 1.42 2.49 3,200 31 Dec 2013
J.P. Morgan Investment Management Inc. 1.35 0.46 1,976 30 Sep 2013
BlackRock Advisors LLC 0.63 0.29 1,718 31 Dec 2013
Stralem & Company Incorporated. 0.19 3.44 1,465 31 Dec 2013
Top 5 Sellers
Scout Capital Management LLC 0.12 1.41 -2,700 30 Sep 2013
Marsico Capital Management, LLC 0.44 1.90 -1,351 30 Sep 2013
Sands Capital Management, LLC 0.95 1.47 -1,294 31 Dec 2013
Quantitative Management Associates LLC 0.16 0.19 -1,238 31 Dec 2013
Montag & Caldwell, LLC 0.54 2.38 -994 31 Dec 2013
Management 23 Jan 2014
Management & Ownership
Management Activity
Fund Ownership
Institutional Transactions
*Represents the date on which the owner’s name, position, and common shares held were reported by the holder or issuer.
Starbucks chairman Howard Schultz returned to the role of CEO in January 2008, replacing Jim Donald. Although we typically prefer the roles of chairman and CEO to be split for corporate governance purposes, we believe the presence of Schultz, who previously served as CEO from 1987 to 2000, has helped reinvigorate the firm the past several years. In fiscal 2012, Schultz received $1.5 million in base salary, which seems reasonable given the firm's impressive fundamentals the past several years. Schultz, however, also was given stock awards, option awards, and nonequity incentive plan compensation of $14.3 million, which strikes us as moderately excessive compared with industry peers.
With a 3.7% stake of Starbucks' common shares, Schultz has sufficient incentive to increase shareholder value, in our opinion. Although we disapprove of certain takeover defenses, we view Starbucks' overall corporate stewardship as exemplary. We remain impressed that, unlike many companies in the consumer cyclical space, Starbucks has shown a willingness to invest in high-growth potential projects like Evolution Fresh, La Boulange, and Teavana the past several years, while simultaneously returning cash to shareholders through dividends and buybacks.
Analyst Notes
As Retail Industry Undergoes Structural Changes, Wide- Moat Starbucks Remains Well Positioned 24 Jan 2014 Despite an in-store traffic slowdown for many retail and restaurant chains over the past few months, Starbucks carried much of its momentum into the first quarter of 2014, underscoring the power of its brand intangible asset and its multichannel approach. Comparable sales growth of 5%-- including 5% gains in both Americas and EMEA and an 8%
gain in China/Asia Pacific--was driven by a 4% increase in transactions through beverage innovations, food platform enhancements, and increased gift card/My Starbucks Rewards use.
U.S. comps of 5% represented 2 times the average for U.S.
retailers this quarter, according to management and Morningstar data. Management's assessment that the traditional retail environment is undergoing a structural shift supports Morningstar's view on the retail industry, with consumers rapidly embracing online and mobile commerce and leaving retailers scrambling to refine their omnichannel strategies. Starbucks' locations admittedly have exposure to a slowdown in retail traffic, and management noted that U.S. comps slowed toward the latter part of December, consistent with commentary from other retailers. However, we believe Starbucks is one of the better-positioned names in the consumer space to adapt to evolving consumer shopping preferences, thanks to a brand that transcends channels; significant investments in its own digital, social media, mobile payment, and loyalty program assets; and an in-store experience that resonates with consumers.
Operating margins were another highlight, increasing 220 basis points to 17.6%, and while easing coffee costs played a role, improvement can also be chalked up to the leverage inherent in Starbucks' model. While the shares trade at only a modest discount to our $78 fair value estimate, we would not require much margin of safety before taking a position, given Starbucks' compelling long-term growth potential
(including emerging-market CPG distribution and consumer awareness of nascent brands).
In our view, the 5% increase in comps in the EMEA region was one of the other key highlights from the quarter.
Although there are still a number of industry headwinds (consumers choosing to eat at home more often and increased promotional activity among specialty coffee chains) and macroeconomic concerns, we view the first- quarter results as a clear indication that Starbucks' EMEA turnaround plan is gaining traction and adds to our confidence that this segment can eventually become a more meaningful free cash flow contributor. It is difficult to attribute the comp gains to any one source, but we believe the acceleration was the result of broad-based efforts to better identify local market preferences (both with respect to products and store designs), supplier negotiations, and applying operational best practices from its U.S. stores to EMEA locations. We also believe the optimization of the EMEA store portfolio, including underperforming store closures and "captive licensing" partnerships (increasing the number of motorway, airport, and train station licensed locations), has positioned this segment for margin improvement as macroeconomic conditions continue to normalize in the region. Our model still assumes low-double- digit operating margins in the EMEA region the next few years, but the first-quarter momentum in this region gives us greater confidence that management is on track to meet its segment goal of midteens operating margins.
There weren't many changes to the company's 2014 goals, outside of a modest uptick in the expected earnings per share range to $2.59-$2.67 from $2.55-$2.65 based on the strength of first-quarter operating margins. This brings management's EPS outlook in line with our internal expectations, and we continue to view other 2014 targets (including top-line growth of at least 10%, mid-single-digit comparable-store sales growth, 1,500 net new stores, and
Analyst Notes
150-200 basis points of operating margin expansion to around 18%) as realistic objectives. There is no change in our five-year revenue growth target in the low-double-digit range, with operating margins improving to around 22%
over the same period.
Starbucks Litigation Charge Does Not Change Our Optimism for Long-Term CPG Opportunities 13 Nov 2013 The arbitrator overseeing Starbucks' packaged-coffee dispute with Mondelez (formerly Kraft) ordered the company on Tuesday to pay Mondelez $2.23 billion in damages and estimated interest and attorneys' fees of $557 million. The arbitration stems from Starbucks' 2010 decision to end its packaged-coffee distribution arrangement with Mondelez (citing poor management of the Starbucks brand in the grocery store channel) and Mondelez's subsequent rejection of Starbucks' $750 million offer to terminate the relationship. Although the final litigation charge is larger than we anticipated, the impact to our fair value estimate will be largely canceled out by cash generated since our last update, leaving our $78 fair value estimate for Starbucks unchanged.
Starbucks plans to fund the litigation payment with cash on hand and additional borrowing, including the issuance of
$750 million in incremental debt during fiscal 2014. As of September 2013, Starbucks had $3.2 billion in cash and short-term investments on its balance sheet, and management does not anticipate repatriating any of the $1 billion in cash it holds overseas to satisfy obligations. Even with incremental interest expense tied to the new debt offering (and likely reduction in interest income stemming from lower cash balances), management reaffirmed its full- year 2014 EPS target of $2.55-$2.65. Our model already forecast earnings moderately ahead of this due to our optimism about Starbucks' wide-moat business model and its channel, geographic, and brand diversification opportunities. The litigation decision will bring our forecast to the high end of the guidance range, and while shares may
seem high at over 29 times our 2014 EPS target, we see a number of positive catalysts on the forefront (including expanded emerging-market CPG distribution and consumer awareness over Starbucks' nascent brands). We view shares as fairly valued at today's prices, but would not require much margin of safety before taking a position.
We share management's view that bringing its packaged- coffee business in house from Kraft was an excellent strategic move. Since making the break from Kraft, Starbucks has capitalized on several new opportunities that weren't available to them under the previous arrangement, particularly in the premium single-serve category. Had management not broken off the arrangement when it did, it ran the risk of letting rivals encroach on this lucrative space instead of turning it into one of the focal points of our long-term valuation assumptions.
Although we're still a bit skeptical of management's claim that its CPG business can eventually rival the company's retail store portfolio in terms of size and profitability, we believe that the contribution from Starbucks' CPG, Foodservice, and Other revenue line will triple over the next 10 years (growing from $1.7 billion, or 11.7% of consolidated sales in fiscal 2012 to nearly $6 billion, or 15% of revenue, in fiscal 2022). By leveraging its blueprint for distributing its premium single-serve products, we believe Starbucks has significant market share potential across the broader coffee, tea, and health and wellness categories (which represent global opportunities of $50 billion, $40 billion, and $50 billion, respectively). We remain comfortable with our average annual revenue growth forecast in the low-double- digit range for this segment from fiscal 2014-18, driven by new innovations, product line extensions, and increasing shelf space within grocery stores and warehouse clubs across the globe. Although additional infrastructure, product development, and marketing investments are likely in the Channel Development segment over the next several
Analyst Notes
years, we anticipate that this segment will continue to see margin expansion in fiscal 2014 (with full-year segment margins somewhere between 32% and 33%, consistent with management's forecast for modest margin expansion relative to the 29.3% posted in fiscal 2013) and heading toward the 40% range over the next several years.
Starbucks 4Q Underscores Wide Moat as Channel, Brand, and Geographic Opportunities Gain Traction 31 Oct 2013
Starbucks' capped off an impressive fiscal 2013 with fourth- quarter results that reinforced our view of the company as one of the most compelling growth stories in the consumer space today. We believe Starbucks is just starting to scratch the surface of its longer-term channel development, brand diversification, and geographic expansion opportunities, and we remain intrigued about the potential mobile, digital, and loyalty program synergies between its different businesses.
The company delivered global comparable sales growth of 7%--including 8% gains in both the Americas and China/
Asia Pacific regions--driven by a 5% increase in transactions through beverage innovations and a revamped food platform (which added 2% to the comp alone in the U.S.), expanded peak hour capacity, and My Starbucks Rewards usage . At a time when most restaurant and retailers are struggling to stimulate transaction growth, Starbucks' transaction gains are impressive and underpin the global strength of its brand. Simultaneously, operating margins increased 220 basis points to 17.6%, and while easing coffee costs played a role, much of the margin gains can be chalked up to Starbucks' leverageable business model.
Taken together, the fourth quarter gave us greater conviction in Starbucks' wide moat and its ability to generate excess economic returns.
We're not planning many changes to our $78 fair value estimate beyond of time value of money adjustments, as
our model already incorporates management's ambitious yet achievable fiscal 2014 targets. While shares may appear lofty at over 30 times the midpoint of next year's EPS target, we continue to see a number of positive catalysts on the forefront (including expanded emerging market CPG distribution and consumer awareness over Starbucks' nascent brands). We view shares as fairly valued at today's prices, but would not require much margin of safety before taking a position given the feasibility of Starbucks long-term growth aspirations.
We believe many of the competitive advantages of Starbucks' core retail operations will extend into its channel, brand, and geographic diversification efforts, putting the company in a unique position to capture retail and wholesale market share over a long horizon. As a result, we have added conviction in management's 2014 guidance, which includes top-line growth of at least 10%, mid-single-digit comparable-store sales growth, 1,500 net new stores (an increase from earlier estimates of 1,400 units and representing approximately 8% unit growth), 150-200 basis points of operating margin expansion (putting full-year operating margins around 18%), and earnings per share of
$2.55-$2.65. With 2014 as a foundation, we remain confident in our five-year revenue growth target in the low- double-digit range with operating margins improving to the 20% range over the same period. We also think that the
$750 million raised through September's senior notes offering provide the company with resources to support additional buyback activity, providing us with added visibility for at least high-teens EPS growth over the next five years. Management also raised its dividend payout range to 45% from 35%, which implies an annual dividend of just under $1.20 per share. While this represents a yield of just 1.5%, we are confident that the dividend will grow in line with the company's earnings over the next several years, providing an attractive investment story for growth and income investors alike.
Growth (% YoY)
3-Year
Hist. CAGR 2011 2012 2013 2014 2015
5-Year Proj. CAGR
Revenue 11.6 9.3 13.7 12.0 11.1 12.1 11.6
EBIT 18.6 15.1 17.2 23.5 27.3 18.3 18.5
EBITDA 15.4 11.2 14.1 20.9 21.6 15.9 16.3
Net Income -79.4 31.7 11.1 -99.4 24,506.6 16.7 238.4
Diluted EPS -79.4 30.8 10.7 -99.4 24,429.3 16.9 238.6
Earnings Before Interest, after Tax 22.5 24.2 24.6 18.8 -1.3 18.5 13.6
Free Cash Flow 7.6 -65.6 83.4 97.2 -304.4 -172.5 23.9
Profitability
3-Year
Hist. Avg 2011 2012 2013 2014 2015
5-Year Proj. Avg
Operating Margin % 13.8 13.0 13.4 14.8 17.0 17.9 18.6
EBITDA Margin % 18.3 17.7 17.8 19.2 21.0 21.8 22.3
Net Margin % 7.0 10.7 10.4 0.1 12.4 12.9 13.3
Free Cash Flow Margin % 4.2 2.3 3.7 6.6 -12.1 7.8 5.2
ROIC % 27.8 24.9 27.1 31.3 24.3 26.5 28.1
Adjusted ROIC % 20.8 18.0 19.4 25.2 16.5 17.6 19.1
Return on Assets % 12.0 18.1 17.8 0.1 18.5 21.2 21.5
Return on Equity % 20.1 30.9 29.2 0.2 41.2 40.6 40.4
Leverage
3-Year
Hist. Avg 2011 2012 2013 2014 2015
5-Year Proj. Avg
Debt/Capital 0.14 0.11 0.10 0.22 0.27 0.25 0.22
Total Debt/EBITDA 0.32 0.26 0.23 0.45 0.59 0.51 0.45
EBITDA/Interest Expense 78.87 62.30 72.41 101.88 60.01 63.78 81.04
2012 2013 2014(E) 2015(E)
Price/Fair Value 0.96 0.99 — —
Price/Earnings 28.3 NM 28.1 24.0
EV/EBITDA 15.4 19.6 16.4 14.1
EV/EBIT 20.4 25.4 20.3 17.2
Free Cash Flow Yield % 2.3 3.0 -3.3 2.8
Dividend Yield % 1.4 1.1 1.3 1.9
Cost of Equity % 10.0
Pre-Tax Cost of Debt % 5.0
Weighted Average Cost of Capital % 9.5
Long-Run Tax Rate % 33.9
Stage II EBI Growth Rate % 8.0
Stage II Investment Rate % 32.0
Perpetuity Year 20
USD Mil Firm Value (%) Per Share
Value
Present Value Stage I 15,723 27.9 20.70
Present Value Stage II 15,773 28.0 20.76
Present Value Stage III 24,894 44.2 32.77
Total Firm Value 56,390 100.0 74.23
Cash and Equivalents 3,234 — 4.26
Debt -1,299 — -1.71
Preferred Stock — — —
Other Adjustments -886 — -1.17
Equity Value 57,438 — 75.61
Projected Diluted Shares 760
Fair Value per Share —
Morningstar Analyst Forecasts
Forecast Fiscal Year Ends in September
Financial Summary and Forecasts
Valuation Summary and Forecasts
Key Valuation Drivers
Discounted Cash Flow Valuation
Additional estimates and scenarios available for download at http://select.morningstar.com.
The data in the table above represent base-case forecasts in the company’s reporting currency as of the beginning of the current year. Our fair value estimate may differ from the equity value per share shown above due to our time value of money adjustment and in cases where probability-weighted scenario analysis is performed.
(USD)
2011 2012 2013 2014 2015
Revenue 11,700 13,300 14,892 16,538 18,540
Cost of Goods Sold 8,510 9,731 10,668 11,609 12,882
Gross Profit 3,190 3,569 4,224 4,929 5,658
Selling, General & Administrative Expenses 749 801 938 986 1,103
Other Operating Expense (Income) 393 430 457 462 521
Other Operating Expense (Income) — — — — —
Depreciation & Amortization (if reported separately) 523 550 621 670 710
Operating Income (ex charges) 1,525 1,787 2,207 2,810 3,323
Restructuring & Other Cash Charges — — 2,784 -20 —
Impairment Charges (if reported separately) — — — — —
Other Non-Cash (Income)/Charges -204 -211 -251 -283 -297
Operating Income (incl charges) 1,729 1,998 -325 3,113 3,621
Interest Expense 33 33 28 58 63
Interest Income 116 95 124 65 68
Pre-Tax Income 1,811 2,060 -230 3,120 3,626
Income Tax Expense 563 675 -239 1,078 1,241
Other After-Tax Cash Gains (Losses) — — — — —
Other After-Tax Non-Cash Gains (Losses) — — — — —
(Minority Interest) -2 -1 -1 — —
(Preferred Dividends) — — — — —
Net Income 1,246 1,385 8 2,042 2,384
Weighted Average Diluted Shares Outstanding 770 773 762 765 764
Diluted Earnings Per Share 1.62 1.79 0.01 2.67 3.12
Adjusted Net Income 1,246 1,385 8 2,042 2,384
Diluted Earnings Per Share (Adjusted) 1.62 1.79 0.01 2.67 3.12
Dividends Per Common Share 0.51 0.66 0.83 0.93 1.40
EBITDA 2,279 2,579 330 3,783 4,331
Adjusted EBITDA 2,075 2,368 2,863 3,480 4,034
Morningstar Analyst Forecasts
Income Statement (USD Mil)
Fiscal Year Ends in September Forecast
2011 2012 2013 2014 2015
Cash and Equivalents 1,148 1,189 2,576 233 191
Investments 903 848 658 658 658
Accounts Receivable 387 486 561 634 711
Inventory 966 1,242 1,111 1,431 1,588
Deferred Tax Assets (Current) 230 197 288 319 358
Other Short Term Assets 162 239 277 308 345
Current Assets 3,795 4,200 5,471 3,584 3,852
Net Property Plant, and Equipment 2,355 2,659 3,201 3,769 4,308
Goodwill 322 399 863 863 863
Other Intangibles 112 144 275 275 275
Deferred Tax Assets (Long-Term) — 97 967 1,074 1,204
Other Long-Term Operating Assets 298 145 185 206 231
Long-Term Non-Operating Assets 479 576 555 838 1,135
Total Assets 7,360 8,219 11,517 10,608 11,868
Accounts Payable 540 398 492 477 529
Short-Term Debt — — — — —
Deferred Tax Liabilities (Current) — — — — —
Other Short-Term Liabilities 1,536 1,812 4,886 2,253 2,526
Current Liabilities 2,076 2,210 5,377 2,730 3,055
Long-Term Debt 550 550 1,299 2,049 2,049
Deferred Tax Liabilities (Long-Term) — — — — —
Other Long-Term Operating Liabilities 348 345 358 397 445
Long-Term Non-Operating Liabilities — — — — —
Total Liabilities 2,973 3,105 7,034 5,177 5,550
Preferred Stock — — — — —
Common Stock 1 1 1 1 1
Additional Paid-in Capital 41 39 282 282 282
Retained Earnings (Deficit) 4,297 5,046 4,130 5,458 6,769
(Treasury Stock) — — — -379 -803
Other Equity 46 23 67 67 67
Shareholder's Equity 4,385 5,109 4,480 5,429 6,316
Minority Interest 8 2 2 2 2
Total Equity 4,393 5,111 4,482 5,431 6,318
Morningstar Analyst Forecasts
Balance Sheet (USD Mil)
Fiscal Year Ends in September Forecast
2011 2012 2013 2014 2015
Net Income 1,248 1,385 9 2,042 2,384
Depreciation 550 581 656 670 710
Amortization — — — — —
Stock-Based Compensation 145 154 142 147 162
Impairment of Goodwill 36 — — — —
Impairment of Other Intangibles — — — — —
Deferred Taxes -31 61 -1,046 -139 -169
Other Non-Cash Adjustments -88 -26 2,671 -283 -297
(Increase) Decrease in Accounts Receivable -89 -90 -68 -73 -77
(Increase) Decrease in Inventory -422 -273 153 -320 -157
Change in Other Short-Term Assets -23 -20 89 -31 -37
Increase (Decrease) in Accounts Payable 228 -136 140 -15 52
Change in Other Short-Term Liabilities 58 85 164 -2,633 273
Cash From Operations 1,612 1,720 2,908 -633 2,845
(Capital Expenditures) -532 -856 -1,151 -1,238 -1,250
Net (Acquisitions), Asset Sales, and Disposals -56 -129 -610 — —
Net Sales (Purchases) of Investments 117 53 378 — —
Other Investing Cash Flows -549 -42 -27 19 23
Cash From Investing -1,020 -974 -1,411 -1,219 -1,227
Common Stock Issuance (or Repurchase) -217 -313 -341 -379 -424
Common Stock (Dividends) -390 -513 -629 -715 -1,073
Short-Term Debt Issuance (or Retirement) 31 — — — —
Long-Term Debt Issuance (or Retirement) -4 — 715 750 —
Other Financing Cash Flows -28 111 147 -147 -162
Cash From Financing -608 -715 -108 -491 -1,659
Exchange Rates, Discontinued Ops, etc. (net) -1 10 -2 — —
Net Change in Cash -16 41 1,387 -2,343 -42
Morningstar Analyst Forecasts
Cash Flow (USD Mil)
Fiscal Year Ends in September Forecast
