Seeking Alpha
, AlexLeAnders (229 clicks)
Long/short equity, research analyst, tech, growth
Profile| Send Message|
( followers)  

Starbucks (SBUX) serves some amazing coffee but it also offers some amazing yields. Investors should anticipate that Starbucks will sustain its high rate of growth based on its international store roll out.

Qualitative Analysis

Source: Information pertaining to SBUX came from the shareholder annual report, shareholder quarterly report, along with YCharts.

Expansion into Asian markets will be the largest contributing factor to long-term growth.

(click to enlarge)

The CAP (Chinese-Asia-Pacific) division shows the most potential in terms of growth. Sales have grown by 11%, the number of transactions grew by 8%, and the change in ticket (sales per transaction) increased by 3% over previous year. The Americas and Asia are the primary growth markets for Starbucks. The capital expenditure has increased, with the majority of SBUX's capital expenditure related expenses going towards its CAP division.

(click to enlarge)

The company has ramped up its capital expenditure well above its average rate of cap-ex spending increases. This means that Starbucks has re-oriented itself into investing capital in Chinese store expansion.

(click to enlarge) Starbucks has increased its store foot print in CAP (China/Asia Pacific) by 35.2%. This is Starbucks' primary growth market and it is likely that capital expenditure spending is going to increase due to its CAP division's promising results. Starbucks has a proven business model that continues to work, so the rapid increase in capital expenditure is not being squandered. This can be based on the fact that its return on shareholder equity has remained constant for the past 3 years.

(click to enlarge)

The return on equity has remained within a reasonable range of 25-30% over the past 3 years. Ulfberht Capital states:

Return on assets is a measure of how much profit is generated from a company's assets independent of how much debt is used to finance the acquisition of those assets. The return on assets is sometimes a better measure of profitability than return on equity because the return on equity can be significantly increased by adding more debt to a company's balance sheet. Adding more debt to a company can inflate profits but comes at the price of a greater risk of bankruptcy.

I disagree with Ulbrecht Capital. Adding debt in this instance will not increase the risk of bankruptcy. Starbucks operates a proven business model that continues to succeed. Furthermore, the low interest rate environment should encourage management to expand its capital expenditure, even if it means increasing the amount of liabilities on its balance sheet. An increase in liabilities in order to maximize returns in an environment of high economic growth (Asia Pacific), and low interest rates should be encouraged by the investment community. Any type of balance sheet concerns is fairly immaterial as financial debt to total equity went from 0.11 in 2009 to 0.0138 in 2012. The company has an extremely low amount of debt relative to shareholder equity.

One upside catalyst however, is the use of debt in order to expand operations. If SBUX's management were to use financial leverage in order to expand into the Asia pacific, that could be a growth catalyst for long-term investors. Starbucks can generate investment capital by issuing bonds in a low-interest rate market (United States) then deploy the capital in a high-growth market (China-Asia Pacific). Taking advantage of low local interest rates then deploying the capital in high growth markets will maximize returns on investment. Debt in the current economic environment can be seen as a positive rather than a negative.

(click to enlarge)

The expanding cap-ex did not result in declining profit margins. Rather, the profit margins have improved throughout the period analyzed, meaning that Starbucks is effective at identifying and executing upon store openings.

The income elastic demand of restaurant meals is 1.61. This means that for each percentage increase in income, consumption of coffee/food will increase by 1.61 times. This is an important indicator as Starbucks' net income from foreign markets will continue to grow and will represent a larger percentage of net-income going forward. In 2010, income GDP per capita worldwide was at $7,329-- by 2020 this is forecasted to be at $9,388. Income on a world-wide basis is likely to grow by at least 28% over the decade. This improvement in income will make for a larger number of Starbucks' store visits, and will contribute to SBUX's foreign revenue growth by an additional 45% over a 10-year period. SBUX's international growth strategy will continue to succeed over the next 10 years.

Ulfberht Capital states that it can be difficult to time the expansion and contraction of a cyclical stock:

Timing when to sell a cyclical stock is even more difficult. Timing the stock market is a matter of luck so it is best to stick with the higher quality stocks where market timing is not as critical to investing success.

Coming out of a recession, cyclical stocks tend to out-perform the non-cyclicals because of the strong economic conditions. My experience has been that high quality stocks should be bought going into a recession for capital preservation, but should not be bought coming out of a recession. Because Starbucks is a cyclical investment it is imperative that investors buy the stock prior to a multi-year bull-market rally. I disagree with Ulfberht Capital on whether or not it is possible to time a cyclical company. I believe that Starbucks will generate substantial growth over the next 30-years. Each major bull-market period lasted anywhere from 30-40 years before a massive market sell-off (based on the Dow chart below).
(click to enlarge)

Source: Chart from freestockcharts.com

It is a good time to consider a position in cyclical stocks like Starbucks because the cyclicals respond to economic growth better, due to demand elasticity. In this case, restaurants and food services companies have a demand elasticity of 1.61. The demand multiplier will help Starbucks grow at higher rates. The higher rates of growth will add further intrinsic value to the stock.

The possibility of a double dip recession is remote. The next major market sell-off based on historical data could take 30 years to happen. My investment time frame is five years. Taking into consideration an economic crash that may not happen for the next 30-years, much less the next five, is foolish. I also believe it is safe to assume that Starbucks will remain a great investment over the next five to ten years.

Technical Analysis

The stock has been on a continuous up-trend since November 2012. On February 15th, 2013 the stock had a minor sell off of 2%. I believe that the stock will pivot on the bottom trend line of the channel, and that investors should position themselves to buy the stock on pull-backs.

(click to enlarge)

Source: Chart from freestockcharts.com

The stock is trading below the 20-, and 50-Day Moving Averages. The stock is trading above the 200-Day Moving Average, and is trading in an up-trend (higher highs, higher lows). I anticipate that the stock will pivot from the bottom end of its channel and trade at a higher valuation.

Notable support is $36.00, $43.50, and $51.80 per share. Notable resistance is $57.00, $61.00, and $71.00 per share.

Street Assessment

Analysts on a consensus basis have high expectations for the company going forward.

Growth Est

SBUX

Industry

Sector

S&P 500

Current Qtr.

20.00%

42.30%

-19.30%

11.20%

Next Qtr.

25.60%

54.70%

26.80%

17.30%

This Year

20.70%

12.00%

25.80%

9.50%

Next Year

21.30%

18.60%

-12.50%

12.50%

Past 5 Years (per annum)

28.39%

N/A

N/A

N/A

Next 5 Years (per annum)

18.57%

11.73%

13.58%

8.71%

Price/Earnings (avg. for comparison categories)

25.72

16.43

14.29

15.88

PEG Ratio (avg. for comparison categories)

1.39

1.12

1.28

2.09

Source: Table and data from Yahoo Finance

Analysts on a consensus basis have a 5-year average growth rate forecast of 18.57% (based on the above table). This growth rate is above the industry average for next 5-years (11.73%).

Earnings History

12-Mar

12-Jun

12-Sep

12-Dec

EPS Est

0.39

0.45

0.45

0.57

EPS Actual

0.4

0.43

0.46

0.57

Difference

0.01

-0.02

0.01

0

Surprise %

2.60%

-4.40%

2.20%

0.00%

Source: Table and data from Yahoo Finance

The average surprise percentage is 10 basis points above analyst forecasted earnings over the past four quarters (based on the above table).

Forecast and History

Year

Basic EPS

Price on (Sept 30th)

P/E Multiple

2003

$ 0.34

13.74

40.41

2004

$ 0.49

21.69

44.27

2005

$ 0.63

23.9

37.94

2006

$ 0.74

32.49

43.91

2007

$ 0.90

25

27.78

2008

$ 0.43

14.19

33.00

2009

$ 0.53

19.7

37.17

2010

$ 1.27

24.61

19.38

2011

$ 1.66

36.47

21.97

2012

$ 1.83

50.31

27.49

Source: Data from YCharts price history is from Yahoo Finance

The EPS figure shows that throughout the 2007-2009 period, revenues dropped as the company was adversely affected by the great recession. Once the United States economy exited the recession in 2010-2011, the company's earnings improved.

(click to enlarge)

Source: Data from YCharts

By observing the chart we can conclude that the business is somewhat cyclical and is affected by macroeconomics. Therefore, one of the largest risk factors Starbucks faces is the slowing of international gross domestic product growth. So, as long as the global economy continues to grow, the company will generate reasonable returns over a 5-year time span based on the forecast below.

(click to enlarge)

By 2018 I anticipate the company to generate $5.08 in earnings per share. This is because of earnings growth, improving global outlook, earnings management and continued development overseas.

The forecast is proprietary, and below is a non-linear chart indicating the price of the stock over the next 5-years.

(click to enlarge)

Below is a price chart incorporating the past 10 years and the next 6 years. It details 16 years in pricing based on my forecast and price history on December 31st of each year.

(click to enlarge)

Source: Data from YCharts and price history is from Yahoo Finance.

Investment Strategy

SBUX currently trades at $54.33. I have a price forecast of $71.99 for September 30th 2013. I believe that Starbucks is undervalued and that it should be trading at a higher premium over the next year.

Short Term

Over the next twenty-four months, the stock is likely to appreciate from $54.34 to $71.99 per share. This implies 32% upside from current levels. The technical analysis indicates an up-trend, while the previously mentioned price forecast using fundamental analysis further supports the trade set-up.

Investors should buy SBUX at $54.34 and sell at $71.99 to pocket short-term gains of 32% between 2013 and 2014. This return on investment is exceptional for short-term investors.

Long Term

The company is a great investment for the long-term. I anticipate SBUX to deliver upon the price and earnings forecast despite the risk factors (competition, regulation, economic environment). SBUX's primary upside catalyst is international expansion, growth, share buy-backs, and managing costs. I anticipate the company to deliver upon my forecasted price target of $169.43 by 2018. This implies a return of 211% by 2018. This is a phenomenal return on investment for a food processing company.

A higher yielding investment opportunity-- albeit having substantially higher risk-- is to buy the Jan 18, 2014 calls at the $60.00 strike. The call premiums trade at $3.15. The price forecast for the end of 2013 is $71.99. The rate of return if the calls expire at $71.99 is 280.6%, the option will break-even when the stock trades at $63.15.

The risk-to-reward on the option strategy is high. The investment comes with moderate risk (1.2 beta).

SBUX has a market capitalization of $40.7 billion; the added liquidity makes this an investment opportunity appropriate for larger institutions that require added liquidity.

Conclusion

Everyone should add a cup of coffee to their portfolio. International expansion is the underlying theme of SBUX's growth story. The conclusion remains simple: Buy SBUX.

Source: The Starbucks Growth Story Has Just Begun