Starbucks: Even With This Great Run, Its Still Undervalued

| About: Starbucks Corporation (SBUX)

Over the past 9 months or so Starbucks (NASDAQ:SBUX) stock price has increased from $45.00 to its present price of $71.56. This price increase represents an impressive 60% gain in a relatively short period of time. Even though there has been an impressive stock price run, I believe that while Howard Shultz focuses on growth in the CAP region and specifically China, there is potential for significantly more upside from this point.

Since taking over the company in 1987, Howard Shultz has grown Starbucks from a small six store franchise to a global company with a market cap of $53.78B. Even though this growth has been incredibly impressive, there have been many mistakes along the way. These mistakes especially early on in the development of the Starbucks brand have shaped the way Howard Shultz has approached the growth of the company. His ability to learn from his mistakes is one of the key factors in the successful development of the Starbucks brand and why there is still more upside potential as the Starbucks brand grows in emerging markets.

In 1987, when the original owners Jerry Baldwin, Zev Siegl and Gordon Bowker sold the Starbucks chain to Howard Shultz who was a former employee, the company had 6 stores in Seattle and was looking to expand its menu items. When Howard Shultz bought the company, he aggressively expanded the company opening up stores in Vancouver B.C. and Chicago Illinois. Within 2 years, Mr. Shultz had grown the chain to 46 stores across the Pacific Northwest and Mid West. Even though the company was growing at an unprecedented pace, there were some underlying issues. Employee moral was very low as many employees did not buy into Mr. Shultz's plan and with increasing overhead costs in 1990 the company reported a loss of $1.2 million. In the face of this adversity, Howard Shultz made significant changes to the way he approached the company's growth and employee relations. These changes are what I believe will make the company's growth in emerging markets successful.

In a 2011 interview Howard Schultz talks about some of the mistakes made early on in the growth of the company and how they will use this experience to successfully reach the emerging markets. In the interview he includes his plans for China, Brazil, Vietnam and India. As China is a market that wants the Starbucks brand, he is focusing on growing the brand there. But he states in the interview, "this move must be done with discipline" as he compared it to the "Gold Rush". "We don't have a rollout plan for 140 of those cities (in China), but we strongly believe that the discipline and the process are in place for us to execute a very big growth plan in China, learning from the mistakes we made in the U.S. (early on)".

Since the Interview in 2011, Howard Shultz has grown the Starbucks store base significantly in the China / Asia / Pacific region (CAP). Since Q4 2010, store growth in the CAP region has increased by 42.83%. Even though the Americas (North, Central and South America) is by far the company's largest region by store count, growth in the CAP zone has outpaced growth in the rest of the world.

According to the company's store count spreadsheet, China alone has outpaced the rest of the world in growth. As of year end 2010 Starbucks had 186 licensed stores while as of Q3 2013, Starbucks had 364 licensed stores. This represents an increase of 95.70%.

As the company has learned from mistakes in the early 1990's, store growth by region does not always equal profits or growth to bottom line. The chart below indicates revenue growth per region compared to Q4 2010.

As the chart above indicates, compared to FY 2010 revenue growth has increased across the board. The CAP region has lead the way with revenue growth exceeding 111%.

Over the past couple of years per store revenues have significantly increased as well, with the CAP zone leading the way. Per store revenues increased by 8.56% in the Americas, 57.59% in the CAP region while per store revenues declined in the EMEA region by 10.67% when comparing to FY 2010.

Looking at the growth in the company using the 2011 interview with Howard Shultz as a reference point, it is evident that there has been significant growth within the company and especially the CAP region.

From the analysis above we can see some strengths in growth are: The rate of growth in the CAP region, Revenue growth in the CAP region and increased of per store revenue in the CAP region. Even though per store revenue in the CAP region has increased by 57.59% over the past three years, the revenue total per store total is significantly less in the CAP region than rest of the world. As this is the case, this will be one aspect of the company to keep and eye on and assess moving forward.

As customers in the CAP region begin to try Starbucks and relate to the brand that Howard Shultz has put forth, there is no doubt that per store revenues will catch up to the rest of the world. As a 57.59% growth in per store revenue indicates attachment with the Starbucks brand has already begun.


In the section below, I will use a couple of different methods to find a valuation of the stock price. In this section, I will use the Discounted Cash Flow valuation model and forward P/E ratios to estimate the current value of each share.

I believe using the Discounted Cash Flow valuation model for Starbucks business to be fair because DCF analysis can help one see where the company's value is coming from and one can generate an opinion based on that.

Even though there are variations in calculating this formula, this model is based off of a terminal value of $67.725B and a WACC of 7.57%. The terminal value $67.725B is based off of the company trading at 25X EBITDA. I believe this to be a fair estimation as currently the company is trading at 37.85X EBITDA. Using these valuations, I have concluded Starbucks value to be $77.01 per share.

In another method, I will use Starbucks forward P/E ratios with estimated earnings to find the value. Currently, Starbucks has a forward P/E of 26.97 and FY 2015 earnings projected at $3.18. These two metrics lead to a target price of $85.76. I believe this to be a fair P/E ratio moving forward. As we look to be heading into a rising interest rate environment, P/E ratios tend to drop during this time. The forward P/E ratio 26.97 is well below the 5 year average for the company. Since 2009 the average P/E ratio for the company is 34.02. Even if I took 7% off an already low forward P/E of 26.97 this would give the company a forward P/E of 25.08. A forward P/E of 25.08 would give the company a value of $79.75 per share.

As of September 7th, Starbucks stock was trading at $71.56 - Using the Discount Cash Flow Formula, this indicates the stock is trading at a 7.62% discount to today's price. If I calculate a valuation using forward P/E ratios this indicates a valuation $85.76 or a discount of 19.84%.


At this point in the market, I believe if you added a 50% position here and waited to see if market would pullback to where the stock price traded closer to 20X to 22X future EBITDA or a valuation between $62.50 to $68.50, I believe there would be great upside potential in the future.


Even though Starbucks stock price has increased from $45.00 to its present price of $71.56 over the past 9 months, I believe the stock has significant upside from here. With Howard Shultz using his vast experience to capitalize on the CAP region specifically China, this will drive cash flows, earnings and the eventually the stock price up. At current levels using the Discount Cash Flow Formula, I have calculated that Starbucks is currently trading at a 7.62% discount to today's price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.