Starbucks Looks Great Value Compared To This Rival

| About: Starbucks Corporation (SBUX)

Summary

In the latest installment of our Head-To-Head series, we pitch two companies from the services sector, Starbucks and Dunkin’, against one another.

The article focuses on the relative strengths and weaknesses of Starbucks and Dunkin’ based on business performance and sustainability/dividends.

It concludes by discussing the current valuations of the two companies, and answers whether Starbucks represents good relative value at current price levels.

Starbucks Background

Starbucks (NASDAQ:SBUX) Corporation was founded in 1985 and is based in Seattle, Washington. It operates as a roaster, marketer, and retailer of specialty coffee worldwide. Its stores offer coffee and tea beverages, packaged roasted whole bean and ground coffees, single serve products, and juices and bottled water. In addition, it licenses the rights to produce and distribute Starbucks branded products to The North American Coffee Partnership with the Pepsi-Cola Company (NYSE:PEP), as well as licenses its trademarks through licensed stores, grocery, and national foodservice accounts. As of September 29, 2013, it operated approximately 10,194 company-operated stores and approximately 9,573 licensed stores.

Team Money Research Rating

Our investment philosophy is to focus on company fundamentals and identify stocks that are displaying strong business performance, that operate sustainably and that pay a decent, well-covered dividend.

We score each company relative to the other on the following criteria within each of our two main buckets:

Business Performance

  1. Return on equity
  2. Return on assets
  3. Operating margins
  4. Quarterly revenue growth
  5. Quarterly earnings growth

Sustainability/Dividends

  1. Debt to equity ratio
  2. Interest cover
  3. Dividend payout ratio
  4. Forward yield
  5. 5 year average yield

Once we have scores for the two buckets, we can then assess whether a company represents good value based on the current prices of the two stocks. We use the following criteria to assess valuations on a relative basis.

Valuation

  1. Forward price to earnings ratio
  2. Price to book value ratio
  3. Enterprise value to EBITDA
  4. Price to sales ratio
  5. 5 year price to earnings growth ratio

So, for example, a company that scores well compared to its rival on the first two buckets (business performance and sustainability/dividends) and that is undervalued relative to its peer (based on the third bucket: valuation) could outperform its competitor going forward.

The table below highlights the data that we will use to score Starbucks and Dunkin' (NASDAQ:DNKN) for the first two buckets.

Stock

Starbucks

Dunkin'

Business Performance

   

Return on equity

2.98%

39.09%

Return on assets

16.57%

5.66%

Operating margins

15.75%

39.12%

Quarterly rev. growth

9.10%

6.20%

Quarterly EPS growth

9.40%

-3.50%

Sustainability/Dividends

   

Debt to equity ratio

41.40%

457.36%

Interest cover

39.40

3.09

Dividend payout ratio

495.00%

59.00%

Forward dividend yield

1.40%

2.10%

5 year average yield

N/A

N/A

Click to enlarge

We then score each company relative to its peer based on the above data, with points being awarded as follows:

1st place: 10 points

2nd place: 0 points

Below are the scores for Starbucks and Dunkin':

Stock

Starbucks

Dunkin'

Business Performance

   

Return on equity

0

10

Return on assets

10

0

Operating margins

0

10

Quarterly rev. growth

10

0

Quarterly EPS growth

10

0

Sustainability/Dividends

   

Debt to equity ratio

10

0

Interest cover

10

0

Dividend payout ratio

0

10

Dividend yield

0

10

5 year average yield

0

0

Total Score

50

40

Click to enlarge

As you can see, Starbucks beats Dunkin' in our first two buckets, with Starbucks scoring 50 points and Dunkin' scoring 40 points. Overall, we were impressed with Starbucks' performance, since it was comfortably ahead of Dunkin' in terms of sustainability. This is, we feel, a key area for investors to consider when interest rates are so low, but are not destined to remain low over the long run. So, a debt to equity ratio of 41.40% is clearly very comfortable for Starbucks, since it equates to an interest coverage ratio of 39.40. Dunkin', on the other hand, disappoints in terms of sustainability and appears to be carrying substantial balance sheet risk, with its debt to equity ratio being a whopping 457.36%. This leaves interest payments relatively tight, with the company able to make them just over 3 times.

In addition, Starbucks scores well in terms of quarterly earnings and revenue growth, with the company delivering strong and consistent growth last quarter. This is highly encouraging, because Starbucks is now a major player in the global service market and, many commentators have stated, does not have the same growth potential as Dunkin'. However, last quarter showed that Starbucks continues to lead the way when it comes to top and bottom-line growth.

Clearly, neither Starbucks nor Dunkin' have a long history of paying dividends (neither have been paying for 5 years, hence the zero scores for that criteria) and, with yields of 1.40% and 2.10% respectively, income-seeking investors may wish to look elsewhere for ideas. Starbucks' dividend payout ratio was, of course, hit by the conclusion of arbitration with Kraft (NASDAQ:KRFT) (which reduced earnings per share by around $2.25) and we expect that to correct to around 40% next year.

Overall, a fairly dominant performance by Starbucks shows, while Dunkin' continues to have potential and is able to deliver better operating margins, a higher yield and is highly profitable, Starbucks continues to be less risky (in terms of its balance sheet) and is delivering higher growth rates.

Valuation

So, we feel that Starbucks has performed very strongly in the first two buckets and, as such, should trade at a premium to its sector peer, Dunkin'. Let's see if it does.

Stock

Starbucks

Dunkin'

Valuation

   

Forward price to earnings ratio

24.79

21.34

Price to book ratio

12.02

12.21

EV/EBITDA

18.85

19.26

PEG

1.60

1.60

Price to sales ratio

3.79

6.61

Click to enlarge

While Starbucks does trade at a premium to Dunkin' based on the forward P/E ratio, it trades at a discount in three of the other four valuation metrics. For example, the two companies' price to book ratios are similar, with Starbucks edging out Dunkin' by 12.02 versus 12.21, while the EV/EBITDA ratio highlights that Starbucks is currently better value than its rival, with it being 18.85 versus 19.26 for Dunkin'. However, the price to sales ratio shows a marked difference in the two companies' valuations, with Starbucks' 3.79 easily beating the 6.61 scored by Dunkin'. Meanwhile, the PEG ratio shows that, while both companies have relatively high P/E ratios, they both offer strong growth prospects. For us, though, Starbucks' current valuation does not fully reflect the difference in quality identified by the first two buckets. Therefore, we feel there could be scope for Starbucks to outperform Dunkin' going forward.

Conclusion

Starbucks is a great quality company that we believe offers good value at current levels. It scored highly on the Team Money Research rating system, beating its sector peer, Dunkin', fairly comfortably. It also appears to be relatively undervalued at current levels, since it trades at a discount on three of our five valuation criteria and, as such, we feel it could outperform its sector peer going forward.

Feedback Request: What do you think about Starbucks? Would you buy, sell or hold right now? Please comment below!

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.