Since achieving its 52-week high of $82.50 in November 2013, the share price of Starbucks (SBUX) has pulled back by almost 14% due to market's negative sentiment on the company's growth prospects in the US market. In my view, the dip indeed presents a great entry opportunity for this quality growth stock as I believe investors' concern is overblown based on the reasons discussed below.
There are numerous drivers for continued strong growth…
Investors' concern mainly focuses on the slowdown of same-store growth in the US market. The company's Q1 2014 performance appears to support this view as the quarterly same-store growth rate came in 5%, missing the 6% consensus estimate. Nevertheless, I believe this modest growth slowdown does not represent an inflection point (what market is currently assuming) for Starbucks' promising growth potential given the following:
- First of all, even the 5% US same-store sales growth is already superior to most of the company's peers in the US market.
- Management admitted that the slowdown is attributed to a sign that consumers are shifting their spending from brick and mortar stores to online. Being able to anticipate the shift in early stage, management has rolled out a few initiatives to mitigate the headwind. The company's gift card program has been very successful. Approximately $1.4B gift cards were sold globally in the past holiday season, which represents a spectacular year-on-year growth of 24%. According to management, only $600M value of the gift cards were spent in Q1 2014, and therefore the remaining impact from the gift card spending will be felt in the remainder of fiscal 2014. Another successful initiative is the Starbucks Rewards digital program. To date, weekly transactions have reached 5M times and approximately 30% of the US consumer purchases are paid through this method. Given the success and management's continued effort in driving further developments of these programs, it is believed that the competition from online spending is likely to have limited impact on the company's store traffic.
- Starbucks acquired bakery chain La Boulange in 2012 with a goal to enrich its bakery menu to lure more store traffic. The company has yet to roll out the menu in its US stores but management indicated that early testing on consumer acceptance was very excited as the new menu has been one of the key drivers for the tested store traffic. Management expects a full La Boulange roll-out by the end of fiscal 2014, which in my opinion will likely bring in a material revenue upside in fiscal 2015 and onwards. Aside from La Boulange menu, management also plans to introduce new offerings including carbonated beverage and tea that would likely increase food attachment rates.
- On the packaged goods front, the company has announced launch plan for a few new products including cold juices, yogurt, granola bars, and dried fruits under Evolution Fresh brand. Given the success of the company's existing consumer packaged products and effective distribution channel, Credit Suisse estimated that the incremental revenue and EPS from these new products would be $750M and $0.14, respectively, with an assumption that Starbucks only captured a small amount of market share in each product vertical.
Lastly, as the company's internal business remains in early stage (small revenue percentage relative to the US sales), it is expected that continued expansion in under-penetrated markets (e.g. China) will serve as a primary long-term growth driver.
Valuations are inexpensive on relative basis…
The stock now trades at 13.4x forward (next 12 months) EV/EBITDA multiple and 25.5x forward P/E ratio. Both metrics are above the comps average (see chart below). However, after factoring in Starbucks' superior consensus long-term earnings growth potential, the stock's PEG is only 1.37x, which is at 14% discount to the comps average (1.60x). Given the company's above-average ROIC and low leverage, I view the discounted PEG to be an attractive valuation level.
Starbucks' forward P/E multiple now trades at 67.4% premium over the same multiple of S&P 500 Index, which is compelling to me provided that 1) the P/E premium averaged at 83% in the past 12 months; 2) Starbucks' long-term earnings growth estimate of 18.6% is considerably above the average estimate of 8.5% for S&P 500 companies; and 3) the stock's PEG is 24% below the level of S&P 500 Index (1.80x) after considering the earnings growth potential.
From a historical standpoint, Starbucks' trailing EV/EBITDA multiple of 15.5x now trades almost in line with its 3-year average of 15.1x despite the facts that (see chart below):
1) The company's annual ROIC metric increased gradually from 20.8% in fiscal 2011 to 25.8% as at December 31, 2013;
2) Annual EBITDA margin increased from 17.7% to 19.8% over the same period and consensus estimate predicts the margin to reach 24.3% by fiscal 2016; and
3) Annual revenue growth increased from 9.4% to 12.2% over the same period and market only anticipates the growth rate to modestly slow down to 10.7% by fiscal 2016.
In summary, my view is that the current pullback has presented an attractive risk reward profile for the stock given the identifiable catalysts and inexpensive valuation just discussed. I believe a buy rating is warranted.
All charts are created by the author except for the consensus estimate tables, which are sourced from S&P Capital IQ, and all financial data used in the article and the charts is sourced from S&P Capital IQ unless otherwise specified.