Starbucks Is Beginning To Look Interesting

Mar.31.14 | About: Starbucks Corporation (SBUX)

Summary

Shares are down almost 7% YTD, presenting an opportunity for long-term investors.

Price target, current yield and dividend growth show a potential for continuous double digit returns.

The long-term growth story is still intact as the company gets into new promising ventures.

Starbucks Corporation (NASDAQ:SBUX) is trading at $73.70 as of this writing and is down almost 7% since the end of 2013. Does this present a buying opportunity for long-term investors?. This article presents a few reasons why Starbucks is getting interesting. Let us get into the details.

Nearing All Time High Yield: As shown in the chart below, Starbucks' current yield of 1.40% is more than its average yield of 1.25%. The highest yield level of 1.56% is not far off either. Obviously Starbucks is still in its infancy when it comes to paying dividends but before you laugh at the paltry 1.40% yield, take a look at the section below.

(click to enlarge)Click to enlarge

(Source: YCharts.Com)

Scorching Dividend Growth:

  • Since dividend initiation in 2010, Starbucks has increased dividends every single year.
  • The average dividend growth rate stands at 32% as the table below shows.
  • The table below assumes the dividend payments for the 4 quarters in 2014 as 26 cents for the first 3 quarters and 30 cents for the last quarter. That means an assumed dividend growth of 15% when the company announces its new dividend in October/November 2014.
  • Given the room in payout ratio and free cash flow, investors can expect the dividend growth rate to be near 20% for the next few years.

(Source: Data from Yahoo Finance)

Trailing Earnings and Free Cash Flow:

  • No, Starbucks is not paying a dividend of $1.02 when it is only earning 15 cents. And a big no, if you are worried about the company's sustainable earnings.
  • The "official" earning per share took a severe beating due to the charges associated with the litigation settlement with Mondelez International (NASDAQ:MDLZ).
  • If we look at "regular" earnings through day to day operations, the last four quarterly EPS were 51 cents, 55 cents, 63 cents, and 71 cents. That brings the trailing twelve months earnings per share to $2.40. The payout ratio based on this number is 42%.
  • Outstanding shares count is at 755 million and current quarterly dividend per share is 26 cents. That means a quarterly dividend commitment of $196 million.
  • Even taking the recent litigation charges into account, the five year quarterly average free cash flow stands at $187 million. In other words, the dividend is sufficiently covered by regular free cash flow. Investors must also remember that since the company is still striving for growth, the expenses are on the high side.

Price Targets:

  • 28 analysts on Yahoo Finance have an average price target of $88, which represents nearly 20% upside from here.
  • Marketwatch.com lists a similar price target from same number of analysts.
  • Trefis.com has a price target equal to the current market price.

Extrapolation:

  • The table below shows what the 5 year yield on cost would look like if Starbucks increases dividends at 10% per year, which is much lower than the current average discussed already.
  • In five years, the yield on cost is very likely to double for an investor buying today. That should also put the yield on this stock well above the market average.
  • Even if we assume no growth in earnings per share, the expected 2019 annual dividend per share of $1.74 is well covered based on current EPS of $2.40.


(Source: Current share price and dividend from Yahoo Finance)

Forward Looking Analysis:

  • Earnings: Earnings are estimated to grow at 20% per year for the next 5 years. This gives Starbucks a PEG of 1.3 versus the industry's 1.7.
  • CEO's Vision: When Howard Schultz speaks we better listen, as he is regarded as one of the best CEOs today. He recently talked about Starbucks' target of achieving $100 billion market cap. The company plans to achieve this by tapping into the emerging markets for coffee growth and by aggressively expanding into the tea industry. The company plans to open 20 more tea stores in the U.S. by the end of fiscal 2014.
  • Beer and Wine: Coffee, drinks, and money. Can it get any better? Starbucks is rolling out beer and wine throughout its stores in the U.S. This is coming after the company strategically tested this concept in a few important locations, like Chicago and Atlanta. Even though it is too early to put in a specific target for this section, this move should ease investors' concerns about the company's over-reliance on coffee.

Conclusion: Starbucks is a bit attractive here but this is not to suggest going full steam. Consider buying on dips to $70 and below for two reasons: a) The stock has bounced up from the $70 level multiple times in the last two years. b) The yield will get much closer to 2% based on the dividend increase (30 cents/quarter) expected towards the end of 2014.

If you are looking for stocks that have current yield, dividend growth, and capital growth potential, you are not going to find too many better alternatives. With McDonald's Corporation's (NYSE:MCD) future being repeatedly questioned, Starbucks might present a nice alternative for investors in the food services sector.

Disclosure: I am long MCD. 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.