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Summary

  • Average free cash flow growth will likely exceed 20% in the next few years driven by healthy sales growth and profitability improvement.
  • Given the consensus long-term EPS growth estimate of 18.5%, Starbucks can sustain a high teens dividend per share growth in the foreseeable future.
  • Dividend yield to cost may reach 2.3% by Q4 2016.

The share price of Starbucks (NASDAQ:SBUX) has dropped by 2.4% year to date, underperforming a gain of 6% for S&P 500 Index. Since 2011, the stock's dividend has grown by 26% CAGR, which let many investors wonder whether the company's track record of strong dividend growth can be sustained going forward. In this article, I will provide readers some perspective on Starbucks' future cash flow and dividend trends.

I have performed free cash flow projections from fiscal 2014 to fiscal 2016 to gauge the company's capacity for future dividend growth. My analysis started with consensus revenue estimates which predict the top line to grow by 10.3% CAGR from $16.5B in fiscal 2014 to $20.0B in fiscal 2016. The company's operating cash flow margin trended from 13.2% to $19.5% in the past 5 years. To be somewhat conservative, I used a 15.3% margin for fiscal 2014, which is consistent with its 5-year historical average (I did not factor in the Q1 2014 litigation impact on operating cash flow given that it is a one-time item). I then assumed the operating cash flow margin to expand by 100 bps per annum and reach 17.3% by fiscal 2016. It is noted consensus view expects approximately 500 bps EBITDA margin expansion from fiscal 2013 to fiscal 2014. Hence, my operating cash flow margin forecasts would seem conservative if the company is able to maintain a steady EBITDA to operating cash flow conversion in the period. For capex, I used management's $1.2B guidance for fiscal 2014 and assumed the figure to gradually rise to $1.4B by fiscal 2016. Based on the fair assumptions, free cash flow was projected to grow by 25.0% CAGR from $1.3B in fiscal 2014 to $2.1B in fiscal 2016 (see chart below).

(click to enlarge)

Given my expectation that the company would have another dividend hike in calendar Q4 2014, I estimated that the total dividend spending in fiscal 2014 would be about $811M based on my assumption of another 20% dividend per share in Q4 2014 and my forecasted share count (discussed later). As such, free cash flow dividend payout ratio in the current fiscal year would be 61.2% which is notably higher than previous years. I then assumed a 19% and 18% annual dividend growth in fiscal 2015 and 2016, respectively (details will be discussed later). As my projected free cash flow CAGR exceeds the dividend spending growth, the free cash flow payout ratio will drop to about 55% by fiscal 2016. In this case, Starbucks' excess free cash flow in each year will grow from $514M to $931M over the forecast period (see chart above).

Assuming that the company will spend $500M per annum in the current and next 2 fiscal years on share buybacks, I estimated that average share count will be reduced to 733M by fiscal 2016 based on a repurchase price of $75 and 12.5% annual price growth. Given my forecasted dividend spending, dividend per share was projected to grow by 19.3% CAGR from $1.09 in fiscal 2014 to $1.55 in fiscal 2016. Compared with consensus EPS estimates, my projections imply that earnings dividend payout ratio will increase just slightly from 41% in fiscal 2014 to 42% in fiscal 2016, which remains somewhat in line with its historical level in the past 3 years (see chart below).

(click to enlarge)

There are a couple of reasons making me believe that my dividend per share forecasts are within a sustainable range. First of all, the free cash flow payout ratio is in a declining trend, this is because my assumed dividend spending growth rate is below the projected free cash flow growth rate. Secondly, the implied earnings dividend payout ratio is in a somewhat steady trend and is in line with historical level. Lastly, Starbucks' consensus long-term EPS growth estimate is now at 18.5%, meaning that the company can support a high teens dividend per share growth without seeing an increasing earnings payout trend.

The chart table shows a quarterly breakdown (on calendar year basis) of my annual dividend per share forecasts. I expect 20% dividend per growth in Q4 2014 and Q4 2015 and the growth may decelerate to 15% in Q4 2016. Yield on cost will continue to rise and is forecasted to reach 2.3% by Q4 2016.

(click to enlarge)

All charts are created by the author, and historical data used in the article and the charts is sourced from S&P Capital IQ, unless otherwise specified.

Source: Starbucks: High Teens Dividend Growth May Last For A While