by Matt Doiron
Starbucks Corporation (SBUX) continues to report strong growth numbers, with stores being packed and lines being long despite its already ubiquitous presence in major U.S. markets and a supposedly cash-strapped middle-class consumer. In the fiscal quarter ending in December (the fourth of the coffee chain's fiscal year), Starbucks experienced an 11% increase in revenue compared to the same period in the previous fiscal year, including 9% growth at company-operated stores and same-store growth of 6%. Earnings were up 13% as the company's net margins actually increased. In that one quarter Starbucks generated over $1 billion in cash flow from operations (though a good chunk of that came from reduced inventories, which is not a sustainable source of cash) compared to less than half that figure in the previous Q1. With only about $250 million in capital expenditures, the company was able to repurchase over $400 million in stock and still add to its cash position.
The market is already pricing in quite a lot of future growth at Starbucks, with the stock trading at 31 times its trailing earnings. We do expect significant buybacks at the company, but the implied growth rate is high enough that it looks to us that Starbucks will have to maintain its current earnings growth rate on top of share count activity in order to justify the current valuation let alone prove a good buy. Analyst expectations imply a forward P/E of 22, so even if the company hits sell-side targets for the next two years it will still likely be depending on double-digit earnings growth for some time beyond that point.
Starbucks placed a close second behind McDonald's Corporation (MCD) in our rankings of the ten most popular restaurant stocks among hedge funds for the fourth quarter of 2012 (find more restaurant stocks hedge funds loved), determined from analyzing funds' 13F filings. Billionaire Steve Cohen's SAC Capital Advisors more than doubled the size of its Starbucks position over the course of the quarter and closed December with 3.5 million shares in its portfolio (see Cohen's stock picks). Renaissance Technologies, whose founder Jim Simons is now a billionaire, initiated a position of 1.4 million shares (check out more stocks Renaissance was buying).
We can compare Starbucks to other high-growth quick service restaurants such as Panera Bread Co (PNRA), Chipotle Mexican Grill, Inc. (CMG), and Dunkin Brands Group Inc (DNKN) as well as to McDonald's as the industry leader in quick service in general. Starbucks actually ends up in the middle of this peer group in terms of trailing P/Es: Chipotle and Dunkin are valued between 35 and 40 times their trailing earnings, while the other two companies trade at a discount. Chipotle, interestingly, has seen falling margins which resulted in only 7% earnings growth in the fourth quarter of 2012 versus a year earlier and Dunkin has been struggling on the top line (though its net income has been up strongly in percentage terms). 15% of Chipotle's outstanding shares are held short, and it certainly does seem that it might be overvalued given the pricing and recent performance. Dunkin's issues are more complicated and it's probably best to wait for more results there.
Panera is clearly another growth play- it carries trailing and forward P/Es of 27 and 20 respectively- but as we've noted, this is at least something of a discount to Starbucks. Earnings growth at Panera was over 30% in its most recent quarter compared to the same period in the previous year, with sales up 15%. It therefore seems like a better buy on the surface. McDonald's' growth rates have been very low, and so while it has the lowest trailing P/E of all of these companies at 18, we don't think that it is a buy right now.
There's a very strange dynamic at work between Panera, Starbucks, and Chipotle: a higher trailing earnings multiple is associated one-for-one with lower earnings growth in the company's last quarterly report from its levels a year earlier. While all three are good companies providing quality products, it might be interesting to investigate these peers more closely and execute a pair trade if it does look like there is a wide discrepancy in value terms.