We have a buy rating on Starbucks (NASDAQ:SBUX) and recently wrote an article on the company. You can read the article here. First of all we would like to point out that the article was written before the company announced the conclusion of its packaged coffee dispute with Kraft Foods (KRFT), but it doesn't change our thesis on SBUX.
An arbitrator has ruled that Kraft is entitled to $2.23 billion in damages plus $527 million in pre-judgment interest and attorneys' fees. KRFT said that it will pass the payment from SBUX to Mondelez International (NASDAQ:MDLZ), the renamed business from which it split off in 2012. Just as reminder to investors, this dispute started in 2011 after SBUX's decision to re-assume direct control of its packaged coffee business from Kraft. Although the outsized judgment was higher than many were expecting and is a near-term negative, the long-term thesis doesn't change. Starbucks is a buy. SBUX's balance sheet remains strong and FCF supports solid cash returns to shareholders in 2014 and 2015.
SBUX has enough liquidity to cover the payment. The company indicated that it intends to take on $750 million in incremental debt, which along with $3.6 billion (including overseas) that the company already has in cash and cash equivalents should be sufficient to make the payment. While it's important to note here that the company does not intend to repatriate its overseas cash to make the payment, even without it the company has adequate liquidity to make the payment to Kraft. SBUX has a strong balance sheet and should remain below the debt leverage targets, such that the incremental debt would not jeopardize SBUX's credit rating. The company is still committed to increase its cash returns to shareholders in 2014 and beyond by increasing dividends and buybacks.
We understand that the arbitrator ruling for ~$2.8 billion was more than most investors were expecting but there are also a few positives to take out of the ruling. Most importantly the longstanding overhang is now eliminated and allows SBUX to be more transparent on its cash returns policy with investors. These judgments are normally tax deductible, which should limit the after-tax cash impact. The Seattle, Washington based company has not yet filed 10K and can book the charge in FY13, which keeps the next year estimates clean. The company maintained its FY14 EPS guidance of $2.55 to $2.65. SBUX remains on track to deliver double digit top- and bottom-line growth in its Channel Development segment in 2014 and in the years ahead. Finally, the company also remains committed to increase cash returns to shareholders in 2014 and beyond via dividend increases and buybacks. The ruling will not have any impact on SBUX's capital spending decisions either and the company still expects to go ahead with planned new store openings and other investments that the company was already planning on making even before the ruling.
So as we mentioned in the beginning of the article, although the $2.8 billion charge was worse than expected, there are a few silver linings to take out of the ruling as listed above. Moreover, the ruling also does not change the long-term investment thesis on SBUX, which is based on company's solid domestic business, SSS and margin beats; strong international growth story, improved growth structure, new product innovation, and potential for increased dividends and repurchases. We reiterate our buy rating on SBUX.
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.