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Before selecting a stock, there are a number of things that you need to consider in order to ensure that you are buying the stock of a high-quality company whose shares are poised to grow in value over time. Some of these concerns include what the company does, its competitive advantages, valuation, dividend payouts and sustainability, and earnings consistency.

Another important thing that you need to consider is the financial condition of the company in question. You want to know if the company is able to continue paying its bills, and how much debt it carries. The balance sheet is one of the most effective tools that you can use to evaluate a company's financial condition. In this article, I will discuss the balance sheet of Starbucks (NASDAQ:SBUX), in order to get some clues as to how well this company is doing.

I will go through the balance sheet, reviewing the most important items, in order to assess the financial condition of Starbucks. The information that I am using for this article comes from the company's website here. Note that this article is not a comprehensive review as to whether Starbucks should be bought or sold, but rather, just an important piece of the puzzle when doing the proper due diligence.

This article might be a bit too basic for some and too long-winded for others, but I hope that some of you can derive benefit from it. More information on how I analyze financial statements can be found at my website here.

Background

As everyone knows by now, Starbucks is known for its high-quality coffee. It buys coffee from suppliers, roasts it, and then sells it in stores. It also sells tea beverages and food items through company-operated stores. Starbucks also sells coffee and tea products through licensed stores, grocery stores, and national food service accounts.

In 2012, 79% of the company's sales came from company-operated stores. 9% of 2012 revenue came from licensed stores in the form of product sales, royalties, and license fees. Consumer packaged goods accounted for 8% of the company's sales in 2012, while institutional food service companies accounted for 4%.

The company's business is divided into four segments. They are Americas, EMEA (Europe, Middle East, and Africa), China/Asia Pacific, and Channel Development.

71% of the company's stores are in the Americas, which accounted for 75% of the company's 2012 sales. The EMEA segment accounted for almost 9% of the company's sales last year; 10% of the company's stores are in this region. China/Asia Pacific accounted for just over 5% of sales; 18% of the company's stores are here. The Channel Development segment of Starbucks consists of packaged coffee and tea products that are sold in grocery and retail outlets. Examples of such products include VIA Ready Brew and the K-Cup pack. This segment accounted for just under 10% of 2012 company sales.

Cash and Cash Equivalents

The first line in the Assets column of the balance sheet is for the amount of cash and cash equivalents that the company has in its possession. Generally speaking, the more cash the better, as a company with a lot of cash can invest more in acquisitions, repurchase stock, pay down debt, and pay out dividends. Some people also value stocks according to their cash positions. Some of the larger and more mature companies tend not to carry a lot of cash on their balance sheets, as they might be more inclined to buy back stock with it, or pay out dividends.

As of June 30, 2013, Starbucks had $2.04B in cash and short-term investments, which can be easily converted into cash. Over the last 12 months, Starbucks repurchased $898M worth of stock, and paid out $600M in dividends. The dividends and buybacks are well-supported by the company's trailing 12-month free cash flow of $1.54B.

Net Receivables

Receivables constitute money that is owed to a company for products or services that have already been provided. Of course, the risk with having a lot of receivables is that some of your customers might end up not paying. For this reason, you usually like to see net receivables making up a relatively small percentage of the company's sales.

Starbucks had a total of $507M in net receivables on its most recent balance sheet, which represents 3.50% of its trailing 12-month sales of $14.5B. For fiscal 2012, 3.65% of its sales were booked as receivables, while that percentage was at 3.31% for fiscal 2011.

Due to the fact that receivables account for such a consistently small part of the company's business, I don't see anything to worry about in this area.

Current Ratio

Another factor that I like to look at is the current ratio. This helps to provide an idea as to whether or not the company can meet its short-term financial obligations in the event of a disruption of its operations. To calculate this ratio, you need the amount of current assets and the amount of current liabilities. Current assets are the assets of a company that are either cash or assets that can be converted into cash within the fiscal year. In addition to cash and short-term investments, some of these assets include inventory, accounts receivable, and prepaid expenses. Current liabilities are expenses that the company will have to pay within the fiscal year. These might include short-term debt and long-term debt that is maturing within the year, as well as accounts payable (money owed to suppliers and others in the normal course of business). Once you have these two figures, simply divide the amount of current assets by the amount of current liabilities to get your current ratio.

If a company's operations are disrupted due to a labor strike or a natural disaster, then the current assets will need to be used to pay for the current liabilities until the company's operations can get going again. For this reason, you generally like to see a current ratio of at least 1.0, although some like to see it as high as 1.5.

The current ratio of Starbucks is 1.75, which is really good.

Property, Plant and Equipment

Every company, regardless of the industry in which it operates, requires a certain amount of capital expenditure. Land has to be bought, factories have to be built, machinery has to be purchased, and so on. However, less may be more when it comes to outlays for property, plant and equipment, as companies that constantly have to upgrade and change their facilities to keep up with competition may be at a bit of a disadvantage.

However, another way of looking at it is that large amounts of money invested in this area may present a large barrier-to-entry for competitors. Right now, Starbucks has $2.99B worth of property, plant, and equipment on its balance sheet. This figure is slightly more than the $2.67B that the company reported at the end of fiscal 2012, and the $2.36B that it reported at the end of fiscal 2011. Of these assets, 57% is in leasehold improvements (improvements that the company made to property that it has leased), 17% in store equipment, and 12% in furniture and fixtures.

Goodwill

Goodwill is the price paid for an acquisition that's in excess of the acquired company's book value. The problem with a lot of goodwill on the balance sheet is that if the acquisition doesn't produce the value that was originally expected, then some of that goodwill might come off of the balance sheet, which could, in turn lead to the stock going downhill. Then again, acquisitions have to be judged on a case-by-case basis, as good companies are rarely purchased at or below book value.

Starbucks has $861M worth of goodwill on its most recent balance sheet, which is significantly more than the $399M worth of goodwill that it reported 9 months prior. It is also higher than the $322M that was reported at the end of fiscal 2011. The increase in goodwill that occurred over the past 9 months is due to the company's $616M acquisition of Teavana Holdings, which sells tea and tea-related merchandise. In this transaction, $466M was allocated to goodwill.

Usually, I don't like to see goodwill account for more than 20% of a company's total assets for the reason that I discussed at the beginning of this section. However, since goodwill only accounts for about 9.5% of the total assets of Starbucks, I don't see anything to be concerned about here.

Return on Assets

The return on assets is simply a measure of the efficiency in which management is using the company's assets. It tells you how much earnings management is generating for every dollar of assets at its disposal. For the most part, the higher, the better, although lower returns due to large asset totals can serve as effective barriers to entry for would-be competitors. The formula for calculating return on assets looks like this:

Return on Assets = (Net Income) / (Total Assets).

For Starbucks, the return on assets would be $1.60B in core earnings over the last 12 months, divided by $9.06B in total assets. This gives a return on assets for the trailing 12 months of 17.7%, which is excellent. I also calculated the returns on assets of Starbucks over fiscal years 2012, 2011 and 2010 for comparative purposes. This can be seen in the table below.

Symbol

ttm

2012

2011

2010

SBUX

17.7%

16.8%

17.0%

14.8%

Table 1: Strong Returns On Assets At Starbucks

Table 1 shows that returns on assets at Starbucks have been excellent over the last few years. This is due to strong earnings growth, coupled with growth in the company's asset base.

Short-Term Debt Versus Long-Term Debt

In general, you don't want to invest in a company that has a large amount of short-term debt when compared to the company's long-term debt. If the company in question has an exorbitant amount of debt due in the coming year, then there may be questions as to whether the company is prepared to handle it.

As of now, this is not a problem at all for Starbucks, as it doesn't have any short-term debt at this time.

Long-Term Debt

Long-term debt is debt that is due more than a year from now. An excessive amount of it can be crippling in some cases. For this reason, the less of it, the better. Companies that have sustainable competitive advantages in their fields usually don't need much debt in order to finance their operations. Their earnings are usually enough to take care of that. A company should generally be able to pay off its long-term debt with 3-4 years' worth of earnings.

Right now, Starbucks carries $550M of long-term debt. This figure is the same as what was reported at the ends of fiscal 2012, 2011, and 2010. This debt was issued back in 2007 as $550M worth of senior notes, with an interest rate of 6.25%, due in 2017. It should also be mentioned that the company priced another $750M in senior notes at a rate of 3.85%, due in 2023. However, this was just done back in September, and is not on the most recent balance sheet.

In determining how many years' worth of earnings it will take to pay off the long-term debt, I use the average of the company's core earnings over the last 3 fiscal years. The average core earnings of Starbucks over this period is $1.19B. When you divide the long-term debt by the average earnings of the company, here is what we find.

Years of Earnings to Pay off LT Debt = LT Debt / Average Earnings

For Starbucks, here is how it looks: $0.55B / $1.19B = 0.46 years

This is great for Starbucks, in that the company could pay off its long-term debt with less than one year's worth of earnings if it wanted to. Even if you add the newly issued debt to the above figure, the company can still pay off the long-term debt with an amount that's equal to just over one year's worth of earnings. For this reason, I don't see anything at all to worry about when it comes to the long-term debt position of Starbucks.

Debt-To-Equity Ratio

The debt-to-equity ratio, as normally calculated, is simply the total liabilities divided by the amount of shareholder equity. The lower this number, the better. Companies with sustainable competitive advantages can finance most of their operations with their earnings power rather than by debt, giving many of them a lower debt-to-equity ratio. I usually like to see companies with this ratio below 1.0, although some raise the bar (or lower the bar if you're playing limbo) with a maximum of 0.8. Let's see how Starbucks stacks up here.

Debt-To-Equity Ratio = Total Liabilities / Shareholder Equity

For Starbucks, the debt-to-equity ratio is calculated by dividing its total liabilities of $3.31B by its shareholder equity of $5.74B. This yields a debt-to-equity ratio of 0.58.

This tells us that Starbucks is in very good shape with regard to its debt and equity positions.

The table below shows how the debt-to-equity ratio has changed over the last few years.

SYMBOL

Q3 2013

2012

2011

2010

SBUX

0.58

0.61

0.68

0.74

Table 2: Debt-To-Equity Ratios Of Starbucks

From Table 2, we can see that the debt of Starbucks is very manageable when compared to its equity position. The debt-to-equity ratio is well below 1.0, and has been very consistent over the last few years. It's actually been trending down just a bit. At this time, I see nothing to worry about with regard to the debt and equity positions of Starbucks.

Return On Equity

Like the return on assets, the return on equity helps to give you an idea as to how efficient management is with the assets that it has at its disposal. It is calculated by using this formula.

Return On Equity = Net Income / Shareholder Equity

Generally speaking, the higher this figure, the better. However, it can be misleading, as management can juice this figure by taking on a lot of debt, reducing the equity. This is why the return on equity should be used in conjunction with other metrics when determining whether a stock makes a good investment. Also, it should be mentioned that some companies are so profitable that they don't need to retain their earnings, so they buy back stock, reducing the equity, making the return on equity higher than it really should be. Some of these companies even have negative equity on account of buybacks. However, Starbucks is not one of these companies.

So, the return on equity for Starbucks is as follows:

$1.60B / $5.74B = 27.9%

This is a very solid return on equity. In the table below, you can see how the return on equity has fared over the past three years.

Symbol

ttm

2012

2011

2010

SBUX

27.9%

27.0%

28.5%

25.8%

Table 3: Excellent Return On Equity At Starbucks

From Table 3, it can be seen that like the company's return on assets, the return on equity has been consistently outstanding, showing that management is making good use of its equity position.

Retained Earnings

Retained earnings are earnings that management chooses to reinvest into the company as opposed to paying it out to shareholders through dividends or buybacks. It is simply calculated as:

Retained Earnings = Net Income - Dividend Payments - Stock Buybacks

On the balance sheet, retained earnings is an accumulated number, as it adds up the retained earnings from every year. Growth in this area means that the net worth of the company is growing. You generally want to see a strong growth rate in this area, especially if you're dealing with a growth stock that doesn't pay much in dividends or buybacks. More mature companies, however, tend to have lower growth rates in this area, as they are more likely to pay out higher dividends.

Below, you can see how the retained earnings have fared at Starbucks at the ends of each of the last four fiscal years.

Symbol

2012

2011

2010

2009

SBUX

$5.05B

$4.30B

$3.47B

$2.79B

Table 4: Retained Earnings At Starbucks

From the above table, you can see that Starbucks has a retained earnings figure of $5.05B, and that the retained earnings have almost doubled since the end of 2009. This has been happening as the company has been buying back stock and paying dividends. While not a dividend growth champion, the company has increased its dividend over the past three years, signaling that perhaps, the company is going to start moving in this direction in the future.

Conclusion

After reviewing the most recent balance sheet, it can be concluded that there are a lot of things to like about the financial condition of Starbucks. For starters, Starbucks has a fantastic current ratio, which shows that the company has more than enough current assets on hand in order to meet its short-term obligations in the event that its operations encounter an unlikely disruption. The company has exhibited very strong and consistent returns on assets and equity over the last several years, showing that the company is making good use of the assets that are at its disposal. The company's debt is also well under control, as can be seen by its consistently low debt-to-equity ratio and the fact that less than one year's worth of earnings could cover its long-term debt. Retained earnings growth has also been excellent, leaving Starbucks with plenty of money to reinvest back into the company for more growth.

At this time, I don't see any immediate concerns at all with the financial condition of Starbucks. However, investors may want to monitor how the company's debt issue last month impacts the balance sheet going forward.

While this is not a comprehensive review as to whether Starbucks should be bought or sold, I think that the company is in very good financial condition, with its manageable debt levels, brand strength, and earnings power.

Source: Wake Up And Smell The Balance Sheet At Starbucks