Monday, December 29, 2014

Starbucks is Still One Heck Of A Growth Play

     First, a caveat.  This analysis is my opinion.  I'm not soliciting bids for nor sales against this security.  Also, do your own research to verify my findings.  Put more bluntly: rely on this at your peril.

Starbucks is the premier roaster, marketer and retailer of specialty coffee in the world, operating in 65 countries. Formed in 1985, Starbucks Corporation’s common stock trades on the NASDAQ Global Select Market ("NASDAQ") under the symbol "SBUX." We purchase and roast high-quality coffees that we sell, along with handcrafted coffee, tea and other beverages and a variety of fresh food items, through company-operated stores. We also sell a variety of coffee and tea products and license our trademarks through other channels such as licensed stores, grocery and national foodservice accounts. In addition to our flagship Starbucks Coffee brand, we also sell goods and services under the following brands: Teavana, Tazo, Seattle’s Best Coffee, Evolution Fresh, La Boulange and Ethos

If you don't know about Starbuck then you obviously haven't left your house in the last 20 years, because in the U.S. at least, their coffee shops are literally everywhere.  And, as they note above, they have a very strong international presence.

Technical Analysis

The weekly chart shows two distinct trends, with the first being a rally that lasted for most of 2013, taking the stock from the lower 40s to the lower 80s.  However, for 2014, the stock made little upward progress, trading in a slightly upward sloping channel who's high (84.20) was only 3.3%above the 2013 peak of 81.15.  The weekly chart did offer several technical entry points over the year when prices traded around the 50 week EMA.  These entry points would have been appropriate for new purchasers or for other long-term investors to increase their positions if they thought growth was continuing.  However, it is probably best to consider 2014 a year-long consolidation of the previous year's rally.

The daily chart (obviously) shows more detail of last year's price action where we see several trends. 

1.) A slight upward sloping trend line connecting the lows of mid-April and mid-October.
2.) An price arc that last from mid-May to mid-October, which took the stock as high as 80, but then sent it back to the lower 70s. 
3.) A second rally that lasted until near year-end.

The reason for the stock's overall stall is it's expensive by most valuation measures.  It's PE is 30 and its P/B is 11.66.  From a valuation perspective, about the only good metric is the PEG ratio which is 1.68.  While not perfect, it does give us a bit of price elasticity.

Now, let's take a look at the company's financials.

Starbucks Balance Sheet

Starbucks has a strong balance sheet, with a current ratio fluctuating between 1.02 and 1.9 for the last few years.  Their overall cash level has fluctuated between $1.8 and $2 billion for the last four years.  They have increased their debt levels to a bit over $2 billion, but their interest coverage ratio is 50, so they've very secure by this metric.  Their inventory turnover ratio has increased from 5.2 to 6.2 over the last few years, but their receivables TO has decreased from 30-27 over the same period.  The only real drawback to their balance sheet is that while revenue has been increasing 10%-11% over the last few years, their receivables increased 25% and then 15% between 2012-2013 and 2013-2014.  The pace of increase was 12% from 2013-2014, which is more in line.  Finally, their book value (assets minus liabilities) has increased from $3.6 billion in 2009 to $5.2 billion in 2024.

Starbucks Income Statement

Despite their size. Starbucks is a growth machine, with top line revenue growth of 9%-13% since the end of the recession.  Their gross margin has decreased a bit from 43%-41%, but their operating margin has increased from 14% to 18% over the last few years.  And their net margin is between 8%-12% over the last few years.  They have decreased their cash conversion cycle from 51-44 days over the last two years as well.  These are the kind of numbers that make for a very predictable situation.

Starbucks Cash Flow

For four of the last five years, SBUX has had positive free cash flow fluctuating between $894 million and $1.7 billion.  In 2014, they had a $2.6 billion liability charge related to an arbitration award granted to Kraft.  According to the most recent 10-K, "This charge included $2,227.5 million in damages and $556.6 million in estimated interest and attorneys' fees."  Aside from the Kraft litigation, SBUX's cash flow is more than adequate to fund property investment, as these expenses have been between 25% and 48% of cash flow from operations.  This gives the company tremendous financing flexibility.  

Conclusion on Financial Statements

SBUX is in a very strong financial position.  They have more then enough cash flow to fund expansion in property.  Their margins are strong with little meaningful fluctuation and revenue growth is strong.  The balance sheet has ample liquidity and the decrease in the cash conversion cycle indicates management is on the ball.

Where Will Growth Come From?

China, pure and simple.  According to their latest 10-K, they have 544 licensed and 823 company owned stores in China as of the end of September, 2013.  Compare those numbers to 4,659 and 7,303 (for a total of 11,962) in the US.  While China has a lower standard of living than the US, and therefore couldn't handle the same number of stores, it's highly conceivable China could open up to 4,500-5000 stores total (about 3,000 more than their current number) and not seriously cannibalize existing sales. 
There are other regions that could also have additional stores.  For example, they only have 434 licensed stores in Mexico, 89 company stores in Brazil and 152 in Germany.  Simply put, there is ample room for international growth for the foreseeable future, largely based on international expansion.

While it may sound cliché to argue that international growth will drive the bottom line, this is one situation where that is more than possible.  Considering their stores require little capital to open -- especially compared to other eateries -- and that the company can open numbers locations, it seems more than obvious that international operations will more than supply growth.
So, yes, I like Starbucks as a company.  (I should confess that I really don't like their coffee).  Now, the question becomes about where to buy.  First, let's get this out of the way: you're not going to buy this at a PE of 4 or when the stock is trading at some level below book value.  That's just not going to happen.  
Over the last year, the upper 60s and lower 70s have been the stock's low points.  In an ideal world, I'd like to wait for those prices to occur again before buying.  However, the chart above also shows that the lower 80s -- should prices move through those levels -- would represent a breakout.  Yes, those levels do represent an expensive company.  But, as I noted above, this stock may be worth it at those levels.