Shares of Starbucks (SBUX) have returned 19.0% over the past 12 months. Is the stock's valuation attractive? Should investors continue to accumulate shares of this fast-growing company? In this article, I will elaborate on the value analysis that may help in formulating your investment decisions.
Starbucks' valuations appear to be reasonable based on the company's solid financial performance relative to its peers (see comparable analysis chart below). Analysts on average predict the company's revenue, EBITDA, and EPS to rise by 2-year CAGRs of 12.4%, 22.2% and 21.2%, respectively, over the current and next fiscal years. The consensus growth estimates are considerably above the averages of 8.8%, 14.1% and 18.6%, respectively, for a peer group consisting of Starbucks' primary competitors. Similarly, the firm's EBITDA margin is forecasted to expand by 3.3% over the same period, compared to the peer average of just 1.2%. On the profit side, however, Starbucks' margin performance is below the par. It should be noted that the company's capital return metric such as ROE and ROIC are fairly in line with peer averages, despite the weak margins. In terms of leverage and liquidity, Starbucks carries a low level of debt as reflected by the firm's below-average debt to capitalization and debt to EBITDA ratios. The firm has a lower free cash flow margin, but the above-average interest coverage ratio, current ratio and quick ratio reflect a solid and healthy corporate balance sheet.
To summarize the financial comparisons, Starbucks' growth nature is characterized by its robust growth potential but below-average profitability. As such, I believe the stock should command a solid valuation premium over the peer-average level given the strong growth prospects. The current stock valuations at 11.7x EV/EBITDA and 23.1x P/E represent an average valuation premium of 19.5% over the peer-average trading multiples, reflecting that the stock should be fairly priced. It is noted that Starbucks' PEG ratio at 1.26x is fairly in line with the peer average of 1.29x.
Based on the current 23.1x NTM P/E multiple and assuming that the analysts' estimated fiscal 2014 EPS of $2.62 can be sustained, the scenario would yield a 1-year target stock price of $60.52.
My DCF model incorporates the market's consensus revenue and EBITDA estimates from fiscal 2013 to 2017 (see DCF chart below). To account for the projection risk, a company specific risk premium of 2.0% is applied. To be conservative ad take a long-term perspective, a normalized risk-free rate of 2.5% is used in the model instead of the current 10-year US Treasury Bond yield.
These reasonable assumptions yield a stock value of $51.15, which is quite close to the current market price. Given that the market's consensus estimates are baked into my model, it would be logical to conclude that the current share price implies approximately a terminal growth rate of 3.5% and a WACC of 10.0% (see DCF chart above), which should be fair assumptions for Starbucks.
According to Thomson One, sell-side analysts' average 1-year target price of $59.13 represents a 13.9% upside from the current market price. The implied 1-year return is not significantly off from my cost of equity estimate at 10.6% (see DCF chart above), meaning that the stock is now trading within the fair value range.
To conclude the value analysis, Starbucks' stock appears to be reasonably valued. In many cases, I usually do not recommend buying a fully-valued stock given the insufficient margin of safety. However, in Starbucks' case, the company's growth opportunities (i.e. emerging market expansion and product roll-outs such as Verismo, K-cups and tea-related offerings) are highly visible in my opinion, especially following the company's acquisition of Teavana (TEA), and thus the investment's risk/reward is still tempting even with a reasonable share price.
Stephens' analyst Will Slabaugh shared the same bullish view in his recent research note (according to Thomson One, Equity Research):
"We continue to believe that SBUX has a very large opportunity to grow its store base to many multiples of the ~5,000 current locations and have confidence the tea industry provides an additional avenue for growth. Utilizing its positioning as a successful global player and brand, impressive international acceptance, and adaptive culture, SBUX should be able to grow the TEA brand and take share from the tea industry that has currently experienced double-digit growth. We would cite that China, India, Russia, Turkey, and the UK make up the five leading consumers of tea globally (U.S is the 6th)."
Bottom line, in the light of the robust growth prospects and the reasonable valuations, Starbucks is a solid buy.
The comparable analysis and DCF charts are created by the author and all financial data in the article and in the charts (except for the highlighted data in the DCF chart, which is author's assumptions) is sourced from Capital IQ.