Starbucks Deserves Valuation Premium

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 |  About: Starbucks Corporation (SBUX)
by: Price Point

Starbucks (NASDAQ:SBUX), the world's largest coffee-shop chain, continues to deliver strong results. The company reported 4QFY13 operating EPS of $0.63, beating consensus estimates of $0.60 by 5%. This is SBUX's third straight EPS beat. The last year has been incredible for the Seattle, Washington based company especially keeping in mind the challenging global macro environment that has pressured earnings of most restaurants and retail chains.

Deserves Credit For Continuous Outperformance

SBUX achieved strong 26% growth in FY13, although it would be irresponsible to assume that the company would be able to achieve the same performance in FY14, still the world's leading roaster of specialty coffee is looking at a solid 16%-20% growth in FY14. SBUX remains a leading global growth story, with an industry leading U.S. retail coffee platform, significant growth opportunities provided by international expansion (particularly China), and company's plans to develop its CPG segment to rival the global retail platform.

Driven by 5% traffic growth and 5% ticket growth, SBUX delivered U.S. comp of 8% which is in the words of management an amazing accomplishment given the size and maturity of the store base. While the broader restaurant industry continues to struggle to post traffic growth and positive comp, SBUX deserves credit for 15 straight quarters of 5%+ comp growth. It shows the ability of SBUX to grow comp despite increasingly difficult comparisons.

SBUX's food platform also continues to contribute to growth. La Boulange products are now available in more than 3,500 Starbucks stores in the U.S and the company remains on track for La Boulange baked goods platform to be available in all 7,000 company operated stores in the U.S by the end of fiscal 2014. Although the company has refrained from quantifying the benefits of La Boulange, it remains confident in the platform's potential.

Liquidity and Dividend

SBUX uses existing cash flow to fund organic growth and leverage has never been the priority of the company. However, recognizing the compelling interest rate environment and where the market conditions have been over the past year, the company decided to enhance its liquidity and took an incremental debt of $750 million. That being said, the company fully truly intends to maintain its strong credit rating and has no immediate plans to take on anything more than $750 million offer it just placed.

The purpose of the debt is not to fund any near-term acquisition rather it's for general corporate expenses and potentially increased share buybacks and increase dividend. SBUX's dividend is expected to be much more sustainable. The company's healthy and consistent cash flow gives it the confidence to grow the dividend rate father than its earnings growth and provides the company flexibility to push the payout ratio higher over time. As far as share buybacks are concerned the company continues to look at them more opportunistically and repurchases are expected to stay at similar to historic levels, though will vary by quarter given the black-out periods.

Valuation

SBUX shares are trading at premium valuations and as the former high growth retail concept moved towards maturity, primarily in the U.S., managing investor expectations have been one of the biggest challenges of SBUX's management. However, in the past two years the company has made some fundamental improvements and re-acceleration of such fundamental growth, both comp and unit, have put necessary managing of expectations on hold. SBUX has also kept investors interest with a number of potential new growth opportunities, most in the early stages of development such as Channel Development. SBUX's premium valuations reflect the resurgence of such growth and re-acceleration in U.S. comps. Over the next few years SBUX will see faster relative EPS growth, have higher ROIC and a healthier balance sheet than its peers, and we believe it warrants premium valuation.

Conclusion

We have a buy rating on SBUX. Stable domestic sales, an emerging international growth story, and a significant opportunity within branded CPG provide visibility on 15-20% EPS growth. Driven by new product innovation, improved cost structure, and improving guest satisfaction, SBUX continues to make progress on its U.S. turnaround. Starbucks is still at an early stage of its international expansion. Driven by implementation of successful initiatives that help turnaround SBUX's domestic business, the company has a long runway for growth at its international business.

With a longer term growth rate of 15%-20%, SBUX is boosting strongest growth in large cap restaurants. As the company improves its ROIC, valuation is also poised for moderate expansion. SBUX also has an under levered balance sheet and its significant FCF provide opportunities for increased buybacks and dividends. The company recently increased its dividend by 24% and has a dividend yield of 1.3%.

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.