Starbucks Will Grow, But Can It Grow Enough?

| About: Starbucks Corporation (SBUX)

By Matt Doiron

Quick service restaurants are hot in the marketplace. Of the ten most popular restaurant stocks among hedge funds in the third quarter of 2012, only one was a classic table-service restaurant. See hedge funds' ten favorite restaurant stocks. In addition, quick service restaurants tend to trade at considerably higher earnings multiples than table-service restaurants. This is because the market believes that consumers are increasingly willing to spend on prepared food as opposed to cooking. One example of this trend is Starbucks Corporation (NASDAQ:SBUX), which is currently valued at 30 times trailing earnings. Starbucks was the third most popular restaurant stock among hedge funds; SAC Capital Advisors and Citadel Investment Group, which are respectively managed by billionaire Steve Cohen and Ken Griffin, increased their positions during the third quarter. See more of Cohen's and Griffin's stock picks.

The fourth quarter of Starbucks Corporation's fiscal year ended in September with the results not being particularly strong. Revenue was up 11% from the same period in the previous fiscal year, but earnings were flat. Wall Street analysts expect $2.16 per share in earnings for the current fiscal year - this would be a 21% increase - and another 21% increase in the fiscal year ending in September 2014. If it does match that trajectory, then its earnings for that fiscal year imply a forward P/E of 21 at the current price. So either high growth would have to continue, for at least a third year in a row, or improvements in the next two years will have to be even stronger.

Starbucks Corporation is currently planning to include more international operations as part of its growth plans. It would generally be assumed that expanding into these geographies would reduce margins. We would note that Yum's trailing P/E multiple is only 19, a discount to where Starbucks trades. The company performed very well in Q3 2012, though it has recently lowered its guidance on Chinese same-store sales and this has impacted the stock price.

We've already discussed Yum as trading at a discount to Starbucks; we believe that Panera Bread Co. (NASDAQ:PNRA) is the company's closest publicly-traded peer. Panera recorded 27% growth in net income in Q3 2012 versus a year earlier, with revenue up at a double-digit rate as well. With a trailing P/E of 30, matching that of Starbucks, it actually seems that Panera might be a more attractive growth stock as the company is already delivering the growth rates that it needs in order to justify its valuation.

We can also compare Starbucks to lower-end competitor Dunkin' Brands Group Inc. (NASDAQ:DNKN) and to Chipotle Mexican Grill, Inc. (NYSE:CMG), which has a similar market position as a growing, premium-priced quick service restaurant. Dunkin' is also expanding, and is expected to see high earnings growth in 2013. Its P/E based on analyst consensus for this year is 23. We think that we would avoid it until the company actually demonstrates some of this growth. Chipotle is down 22% in the last year after market expectations proved too high, and 14% of the outstanding shares are still held short. However, its revenue and earnings growth rates are in the 20% range - as with Panera, it is difficult to recommend Starbucks over a similarly-priced company whose recent growth rates have been much stronger.

We aren't sure if we like any of these stocks - even Panera and Chipotle, despite their impressive growth rates, derive much of their value from future earnings that the companies have yet to achieve. They do, however, demonstrate that Starbucks isn't very appealing right now. Perhaps the company will provide strong results in the next quarter or so, but for now we would stay away from the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article is written by Insider Monkey's writer, Matt Doiron, and edited by Meena Krishnamsetty. They don't have any business relationships with any of the companies mentioned in this article and they didn't receive compensation (other than from Insider Monkey and Seeking Alpha) to write this article.