Following the release of Starbucks (SBUX) fiscal first quarter earnings announcement investors have been digesting the company's upcoming spending binge. Although the company earned a record $3.8 billion in revenue during the quarter, 2013 appears to be a year of investment for the company. While the company is still projecting EPS growth of 15%-20% year over year, cash flow projections will be drastically altered by the recent announcement.
Teavana was acquired on December 31st making it a wholly owned subsidiary of Starbucks. Since the acquisition date was one day after the recent quarter end, investors will have to wait until FQ2 ends before we see how the purchase affects future financial statements. All that is known at the present moment is a $600 million cash purchase price. Additionally the company intends to spend $1.2 billion on capital expenditures throughout the year, an increase of roughly 40% over fiscal year 2012. Both of these will substantially affect the company's cash position, however given the nearly $2.4 billion in cash and short term investments on the balance sheet, it certainly does not cause reason for concern.
My Thoughts on the Future
Management did not provide vastly new information for the current fiscal year than reported at the end of FY12. A few changes were made to my estimates for the current and upcoming fiscal year. You can read my original estimates in the prior article, but to highlight the most relevant and point out some changes:
- Management is projecting revenue growth of 10-13%, my estimate uses 12% revenue growth. This revenue estimate is a result of management projecting 1,300 new store openings and mid-single digit same store sales growth
- Full year operating margin improvement of 100 basis points (guidance provided by management)
- Depreciation and amortization expense growing 9% as a result of increased CapEx spending and acquisitions
- Interest income declining by 5% as a result of cash used for Teavana purchase
- A slightly lower share count as a result of the share repurchase program (note Starbucks had 761,300,000 diluted shares as of the recent quarter end). As of December 30, 2012, 29.1 million shares remained available under the share repurchase program. Estimates moving forward for diluted share count may be changed based upon management's decision to buy back shares.
- Although not listed in the table below, the company includes "restructuring charges" and "property sale gains" as operating income/expense. I disagree with this treatment of specific line items, and if any are to occur in 2013 or 2014, my models will be updated to include those below the line item "operating income."
Please note that the estimates below are not guaranteeing any of the results will be met. These estimates are strictly based upon management's guidance, the company's SEC filings, press releases, and historical data. (CS=Common size, % of revenue)
2013 | 2014 | |||||
Full Year Estimate | CS | YOY Growth | Full Year Estimate | CS | YOY Growth | |
Revenue | $ 14,895,440,000 | 100.00% | 12.00% | $ 16,645,654,200 | 100.00% | 11.75% |
Cost of Revenue | $ 6,516,755,000 | 43.75% | 12.10% | $ 7,290,796,540 | 43.80% | 11.88% |
Gross Profit | $ 8,378,685,000 | 56.25% | 11.92% | $ 9,354,857,660 | 56.20% | 11.65% |
Store Operating Expenses | $ 4,319,677,600 | 29.00% | 10.25% | $ 4,702,397,312 | 28.25% | 8.86% |
Other Operating Expenses | $ 484,101,800 | 3.25% | 12.61% | $ 532,660,934 | 3.20% | 10.03% |
Depreciation and Amor. Exp | $ 600,000,000 | 4.03% | 9.03% | $ 624,212,033 | 3.75% | 4.04% |
General and Admin Exp | $ 856,487,800 | 5.75% | 6.90% | $ 965,447,944 | 5.80% | 12.72% |
Income from equity investees | $ 248,626,000 | 1.67% | 18.00% | $ 293,378,680 | 1.76% | 18.00% |
Operating Income | $ 2,367,043,800 | 15.89% | 18.51% | $ 2,823,518,118 | 16.96% | 19.28% |
Interest income and Other, net | $ 89,372,640 | 0.60% | -5.33% | $ 108,196,752 | 0.65% | 21.06% |
Interest Expense | $ (32,700,000) | -0.22% | 0.00% | $ (32,700,000) | -0.20% | 0.00% |
Pretax Income | $ 2,423,716,440 | 16.27% | 17.71% | $ 2,899,014,871 | 17.42% | 19.61% |
Provision for income taxes | $ 799,826,425 | 5.37% | 18.60% | $ 956,674,907 | 5.75% | 19.61% |
Net earnings | 1,623,890,015 | 10.90% | 17.27% | $ 1,942,339,963 | 11.67% | 19.61% |
Net earnings (loss) non controlling interests | $ 1,000,000 | 0.01% | 11.11% | $ 1,000,000 | 0.01% | 0.00% |
Net Earnings Total | 1,622,890,015 | 10.90% | 17.28% | 1,941,339,963 | 11.66% | 19.62% |
Basic Shares Outstanding | 745,000,000 | 745,000,000 | ||||
Basic EPS | $ 2.18 | $ 2.61 | ||||
Diluted Shares Outstanding | 760,000,000 | 760,000,000 | ||||
Diluted EPS | $ 2.14 | $ 2.55 |
Source: Starbucks SEC Filings, Starbucks Management Guidance, and my estimates based upon historical data and future expectations. Estimates given above are no guarantee of future results, please evaluate the company in greater detail before making investment decisions.
Valuation using P/E
Shares of SBUX currently trade at just under 30x trailing twelve month earnings. Assuming the company can continue to grow same store sales in the high-mid single digit range, improve operating margins, and grow EPS in the 15-20% range which management projects, a high multiple is likely warranted. Assuming my projections above lean towards the conservative side, and the stock trades at 27x TTM earnings in FY13 and 26x TTM earnings in FY14:
- End of Fiscal year 2013 value = $2.14 diluted EPS X 27x P/E ratio = $57.78 per share, roughly 3.5% from current levels
- End of Fiscal year 2014 value = $2.55 diluted EPS X 26x P/E ratio = $66.30 per share, roughly 19% from current levels
The chart below shows the stock's quarterly trailing twelve month price-to-earnings ratio. Although still at lofty levels, until the company begins to show signs of slowing down, it is likely this ratio will remain elevated.
(click to enlarge)
Source: Starbucks SEC Filings
Note that my projections above do not factor in the current quarterly cash dividend of $0.21 per share. While no dividend increases are guaranteed, I anticipate this rate to be bumped up to $0.25 per share around the same time next year.
Valuation Using Discounted Cash Flow
While many investors tend to use a discounted cash flow analysis, utilizing this measure with Starbucks may not be the best approach. Depending on your expectations for near term growth rates, discount rates, and terminal growth rates, shares appear significantly overvalued. I think this measure should be evaluated carefully due to the significant increase in CapEx and acquisitions. When these levels begin to normalize, DCF analysis should provide a more reasonable value of shares.
When presenting free cash flow for Starbucks I like to factor in acquisitions. Since Starbucks is somewhat reliant on acquisitions to continue growing at such a rapid pace, I feel this is an appropriate line item to include. In my estimates below I factor in 5% Operating cash flow growth for 2013 and 2014. My estimates are quite conservative and it should be noted that the company had over $1 billion in cash flows from operations during the first fiscal quarter alone. In fiscal 2013 you can see management's estimates for $1.2 billion in CapEx and the $600 million acquisition of Teavana. Both these line items will significantly reduce free cash flow in FY13. For FY14 I estimate a more normalized acquisition year with similar CapEx spending. We may get updated guidance from management on this further out in the year. Note that most of the CapEx spending is due to new store openings which we will review in the section below.
2010 | 2011 | 2012 | 2013 estimate | 2014 estimate | |
Operating Cash Flow | $1,704,900,000 | $1,612,400,000 | $1,750,300,000 | $1,837,815,000 | $1,929,705,750 |
Acquisitions, net of cash acquired | -$12,000,000 | -$55,800,000 | -$129,100,000 | -$600,000,000 | -$100,000,000 |
Additions to PPE | -$445,800,000 | -$531,900,000 | -$856,200,000 | -$1,200,000,000 | -$1,200,000,000 |
Cash proceeds from sale of PPE | $5,100,000 | $117,400,000 | $5,300,000 | $0 | $0 |
Free Cash Flow | $1,252,200,000 | $1,142,100,000 | $770,300,000 | $37,815,000 | $629,705,750 |
Source: Starbucks SEC Filings, Starbucks Management Guidance, and my estimates based upon historical data and future expectations. Estimates given above are no guarantee of future results, please evaluate the company in greater detail before making investment decisions.
Store Count Growth
After a few years of minimal store growth, 2012 appears to be the year Starbucks is back to a rapid expansion phase. Last year the company added over 1,000 stores and is projecting 1,300 new stores this year. 500-600 of those stores will be in China, the company's most promising growth opportunity. Based upon the trends in the table below, we may see Starbucks' expansion play out for the next few years. As I mentioned earlier, this will have an impact on free cash flow and the DCF analysis.
Store Count | Growth Rate | Store Increase | |
2002 | 5,886 | ||
2003 | 7,225 | 22.75% | 1339 |
2004 | 8,569 | 18.60% | 1344 |
2005 | 10,241 | 19.51% | 1672 |
2006 | 12,440 | 21.47% | 2199 |
2007 | 15,011 | 20.67% | 2571 |
2008 | 16,680 | 11.12% | 1669 |
2009 | 16,635 | -0.27% | -45 |
2010 | 16,858 | 1.34% | 223 |
2011 | 17,003 | 0.86% | 145 |
2012 | 18,066 | 6.25% | 1063 |
2013 Q1 | 18,278 | 212 | |
2013 Estimate | 19,366 | 7.20% | 1300 |
Source: Starbucks SEC Filings
While unexpected costs that come along with expansion may scare away short term investors, long term investors will likely see value being created. Scaling into positions on pullback is one approach to gain exposure to the company. If the company can continue to make a footprint in other countries similar to that of North America, the future looks promising. Additionally the company's ability to increase average ticket size and transaction in North America (an already saturated market), should carry over to other emerging markets.
Potential Risk
Although Starbucks is subject to numerous risks which you can read in the recent 10-K filing, one that caught my eye is the legal battle with Kraft (KRFT). The dispute has been going on since 2011 and Kraft is seeking damages of $2.9 billion plus attorney fees. Starbucks believes this number is "highly inflated and based upon faulty analysis." A decision from the arbitrator is expected during the first half of fiscal 2013 regarding this matter. Given the fact that no loss contingency has been recorded, one would assume management is somewhat confident that Kraft is in the wrong. My concern comes from the following statement in the recent 10-Q, "At this time, Starbucks believes an unfavorable outcome with respect to the arbitration is not probable, but as noted above is reasonably possible". While I am not attempting to predict an outcome, any news which is unfavorable to Starbucks could have negative impact on the stock price.
Conclusion
Following Starbucks' biennial investor conference, management set up some very lofty goals for the future. Revenue growth is expected to be 10%+, Same-store-sales growth between 3%-7% and EPS growth of 15-20%. If these targets can be achieved over the next few years, shareholders will likely see capital appreciation in addition to the dividend.
Consider your investment goals and objectives before initiating a position in Starbucks and please remember that the value of investments in equity securities, like SBUX, will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. Since I attempt to tailor my estimates above conservatively, any upside surprises would be beneficial. In my opinion, being a long-term shareholder has the potential to provide attractive returns.
Note: All data reported and graphed is pulled directly from Starbucks' SEC Filings and Investor Presentations.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
