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Company Description
Starbucks Corporation was formally founded by Jerry Baldwin and Howard D. Schultz on November 4, 1985, 14 years after the first store was opened in Pike Place Market, Seattle, WA. Starbucks is one of the leading premier specialty coffee shops and stores today.
While headquartered in Seattle, WA, the company operates globally through the following segments: Americas; China/Asia Pacific (CAP); Europe, Middle East, and Africa (EMEA); and Channel Development. Starbucks retail stores worldwide sell coffee, signature beverages, teas, breakfast sandwiches, pastries, lunch items and merchandised drinkware. The Channel Development segment is where Starbucks sells its goods to partnered foodservice industries. Starbucks operates 29,324 independent stores as of November 1st of this year.
GICS Sector: Consumer Discretionary
This sector is comprised of industries that are sensitive to economic cycles. The manufacturing sub-segment includes automotive, household durable goods, textiles and apparel, and leisure equipment. The services sub-segment includes hotels, restaurants, media production, and consumer retail.
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Management
Starbucks has achieved an Exemplary Stewardship rating based on having one of the deepest management benches in the consumer sector; its management team is its most experienced since inception in 1985. Due to its Exemplary rating, Starbucks is expected to overcome the soft transaction trends as of late. Within the last couple years, CEO Howard Schultz handed the reins to President/COO Kevin Johnson back in April 2017, and he has since stepped down as chairman in June 2018.
Investors can be reassured by the depth of management team talent in addition to the exemplary stewardship rating. Johnson is backed by the executive team: COO Roz Brewer, core retail head John Culver, Siren retail head Cliff Burrows, and CSO Matt Ryan. With consumer technology backgrounds from prior leadership roles at Juniper Networks and Microsoft, Johnson proves to be a key asset in the company’s expansion into the digital platform.
Cyclical Themes
While dominating the market share, Starbuck’s brand popularity could potentially be its downfall down the road. Due to the cyclical nature of the stock, any recessive trends in the market could result in catastrophic revenue losses for the company as consumers tighten their wallets to save or spend where the equivalent goods or services would be cheaper.
Fundamentals
Starbucks still has the potential to grow domestically by introducing new store formats (express stores, drive-thrus, and kiosks) in addition to the traditional sit-in café setup. The company can diminish the bottleneck effect during peak-hours through technological advancements, expanded prepared-food offerings, and simplifying orders through the use of Mobile Order & Pay.
The investors’ main concern has surrounded transaction trends and the effect on revenue. These strategies are designed to increase transaction rates by encouraging and rewarding brand loyalty, simplifying store operations which in turn decrease consumer wait times, closure of underperforming stores, and a reduction in overall expenses.
Model / Consensus Assumptions
Starbucks’ revenues grew by 5.03% in 2017 and 10.44% in 2018. Earnings per share grew 4.19% in 2017 and skyrocketed in 2018 at 64.32%. The large spark in growth was largely due to the overall market performance between the last two years. I would not expect growth rates to continue at such a steep rate. We can assume that growth trends will continue while Starbucks is implementing its strategies discussed above successfully and there are no major changes in the market.
Valuation
Starbucks is expected to generate $2.02 in free cash flows in 2018, which is lower than the earnings per share (EPS) of $3.24. The FCF yield is 1.98%.
The five-year growth forecast predicts 12.1% growth for Starbucks stock, which is expected to outperform the S&P 500 benchmark by 100 basis points (11.1%).
Risks
Consumer companies that will potentially acquire high-growth projects are preferred, all the while continuing to issue dividends to shareholders and offering buybacks of shares. Starbucks has made numerous investments and acquisitions such as Princi, Teavana, Evolution Fresh, and La Boulange. With these acquisitions, management has proceeded with store closures of La Boulange and Teavana. After making large mergers and acquisitions, Starbucks will need to be more selective with M&A decisions in the future. Any future store closings or missteps in execution could downgrade the company’s Exemplary Stewardship ranking.
Johnson’s base salary was $1.2 million in 2017. He also collected stock and option awards, and nonequity incentive plan compensation of $10.2 million. This plan, and the additional fact that he holds less than a 1% stake in the company’s common shares, causes concern for investors that his interests may not be directly in line with those interests of shareholders.
Actions
Due to the current valuation of the stock, it is difficult to determine if buying or shorting the stock in the near future would be most beneficial to a portfolio due to the wide economic moat – (consider buy – 44.80; consider sell – 86.40). If the market continues to perform, buying the stock now would require the stock price to rise significantly, and according to Morningstar’s Wall Street Estimates the stock price is already overvalued.
I would expect the stock price to drop, as we have experienced volatile market trends in the last few weeks. If you bought into Starbucks earlier in the year, I would recommend selling the holdings if the gains were significantly large enough to impact the portfolio.
Due to forecasted recession trends, increased Fed interest rates, and bearish traits coming forth, I would strongly recommend taking a position of shorting the stock, betting that the stock price will indeed follow the market cycle and decrease in the coming 6-18 months due to decreased consumer spending affecting Starbuck’s revenue negatively.
