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Background

The rise of Starbucks (NASDAQ:SBUX) as a global brand has been a phenomenon that has not gone unnoticed. But like Icarus, Starbucks has flown on a flimsy apparatus and is bound to come crashing down sooner or later.

Having an outlet in every mall and nearly every major street corner, it's been no surprise why this stock has been on the rise. But take a look at the big picture and the numbers and you will come to realize that this company is not worth the hype. While Starbucks has made coffee palatable through sugar saturation, coffee drinkers are maturing and seeking cheaper and better coffee.

Access to good espresso coffee via cafes, micro roasters and affordable espresso machines mean that the gimmicky tricks that Starbucks uses to lure mostly teenagers seeking their sugar rush is not a sustainable model. I live in Sydney where we have access to a multitude of cafes serving awesome coffee that is cheaper than Starbucks'. Furthermore, Starbucks faces stiff competition in the "sweet drinks" category from other chains like Gloria Jeans etc.

Putting aside observations, I have constructed a cash flow analysis to show why this stock is extremely overpriced, even with generous growth prices.

Numbers Don’t Lie

Here is a snapshot of Starbucks' projected NPAT using growth figures of 10%,10%, 8%, 3% and 5% for the years 2011-2014 (with a terminal growth rate of 5%).

Year 2009a 2010a 2011e 2012e 2013e 2014e 2015e
Revenue 9896.5 10855.5 11886.8 13075.4 14121.5 14545.1 14981.5
Cost 8799.8 8925.7 9773.6 10751.0 11611.1 11959.4 12318.2
(cost ratio) 89% 82%
EBITDA 1096.7 1929.8 2113.1 2324.4 2510.4 2585.7 2663.3
Depreciation and amortization 534.7 510.4 558.9 614.8 664.0 683.9 704.4
EBIT 562.0 1419.4 1554.2 1709.7 1846.4 1901.8 1958.9
Interest 2.1 -17.6 -19.3 -21.2 -22.9 -23.6 -24.3
EBT 559.9 1437.0 1573.5 1730.9 1869.3 1925.4 1983.2
Tax expense 168.4 488.7 535.1 588.6 635.7 654.8 674.4
NPAT 391.5 948.3 1038.4 1142.2 1233.6 1270.6 1308.7

Here is how I’ve calculated my FCFF and FCFE (note, all the projected values are based on simply using the 2010 ratio to sales).

BALANCE SHEET 2009a 2010a 2011e 2012e 2013e 2014e 2015e
Current Asset
overdraft 0.3 0.0 0.0 0.0 0.0 0.0 0.0
cash 599.8 1164.0 1274.6 1402.0 1514.2 1559.6 1606.4
short-term securities 21.5 236.5 259.0 284.9 307.7 316.9 326.4
trading securities 44.8 49.2 53.9 59.3 64.0 65.9 67.9
receivable 271.0 302.7 331.5 364.6 393.8 405.6 417.8
inventories 664.9 543.3
prepared expenses 147.2 156.5 171.4 188.5 203.6 209.7 216.0
deferred tax 286.6 304.2 333.1 366.4 395.7 407.6 419.8
total current assets 2036.1 2756.4 2423.3 2665.7 2878.9 2965.3 3054.3
Non-Current Asset
long-term inv 71.2 191.8 210.0 231.0 249.5 257.0 264.7
equity and cost 352.3 341.5 373.9 411.3 444.2 457.6 471.3
property 2536.4 2416.5 3218.2 3540.0 3823.2 3937.9 4056.0
other assets 253.8 346.5 379.4 417.4 450.7 464.3 478.2
other intangibles 68.2 70.8 94.3 103.7 112.0 115.4 118.8
goodwill 259.1 262.4 1616.3 1777.9 1920.1 1977.7 2037.1
tot non-current assets 3541.0 3629.5 4275.8 4703.4 5079.7 5232.1 5389.0
TOTAL ASSETS 5577.1 6385.9 6699.2 7369.1 7958.6 8197.4 8443.3

Current liabilities
short term debt 0.0 0.0 1322.9 1455.2 1571.6 1618.7 1667.3
accounts payable 267.1 282.6 309.4 340.4 367.6 378.7 390.0
accrued compensation 307.5 400.0 438.0 481.8 520.3 536.0 552.0
occupancy 188.1 173.2 189.7 208.6 225.3 232.1 239.0
accrued taxes 127.8 100.2 109.7 120.7 130.3 134.3 138.3
insurance 154.3 146.2 160.1 176.1 190.2 195.9 201.8
other 147.8 262.8 287.8 316.5 341.9 352.1 362.7
deferred revenue 388.7 414.1 453.4 498.8 538.7 554.8 571.5
total current liabilities 1581.3 1779.1 3271.0 3598.1 3886.0 4002.5 4122.6
non current liabilities
long term debt 549.3 549.4 601.6 661.8 714.7 736.1 758.2
other 389.6 375.1 410.7 451.8 488.0 502.6 517.7
total non-current 938.9 924.5 1012.3 1113.6 1202.6 1238.7 1275.9
TOTAL LIABILITIES 2520.2 2703.6 4283.3 4711.7 5088.6 5241.3 5398.5
Share Capital 263.7 211.1 231.2 254.3 274.6 282.8 291.3
Retain Profits 2793.2 3471.2 3801.0 4181.1 4515.5 4651.0 4790.5
Total Shareholder's Equity 3056.9 3682.3 4032.1 4435.3 4790.2 4933.9 5081.9
Net Debt 524.1 68.0 1397.4 1537.1 1660.1 1709.9 1761.2
CASH FLOWS 2009a 2010a 2011e 2012e 2013e 2014e 2015e
EBITDA 1096.7 1929.8 2113.1 2324.4 2510.4 2585.7 2663.3
Change in working capital 0.0 522.5 -1825.0 -84.8 -74.6 -30.2 -31.1
Net interest paid 2.1 -17.6 -19.3 -21.2 -22.9 -23.6 -24.3
Tax paid 168.4 488.7 535.1 588.6 635.7 654.8 674.4
Operating cashflow 926.2 936.2 3422.2 1841.8 1972.2 1984.7 2044.2
Capex 0.0 625.4 -1266.5 241.6 212.6 86.1 88.7
Investing Cashflows 926.2 310.8 4688.7 1600.2 1759.6 1898.6 1955.6
Dividends paid -14.0 -11.9 -13.1 -14.4 -15.5 -16.0 -16.5
Financial Cashflow
NET CHANGE IN CASH 912.2 298.9 4675.6 1585.8 1744.0 1882.6 1939.1
FCFE 926.2 -211.7 6513.7 1685.0 1834.2 1928.8 1986.7
FCFF 926.2 310.8 4688.7 1600.2 1759.6 1898.6 1955.6

Note: capex = (yr 1 currentA-currenL)-(yr0 current A-currentL)

Change in working capital = (yr1 totalA-totalL)-(yr0 totalA-totalL)

I then used the DCF and FCFF to calculate per share value:

Cash flows 2008 2009a 2010a 2011e 2012e 2013e 2014e terminal
Growth 10% -5% 10% 10% 10% 8% 3% 5%
EBITDA $m 1096.7 1929.8 2113.1 2324.4 2510.4 2585.7 2663.3
Capex $m 0.0 625.4 -1266.5 241.6 212.6 86.1 88.7
Tax $m 168.4 488.7 535.1 588.6 635.7 654.8 674.4
Cashflow $m 928.3 815.7 2844.5 1494.2 1662.1 1844.8 1900.2
FCFF 926.2 310.8 4688.7 1600.2 1759.6 1898.6 1955.6
WACC 12.85%
Discounted CF $m 2520.6 1173.3 1156.5 1137.5 13225.47
Discounted FCFF 4154.8 1256.5 1224.3 1170.7 13611.1
fcff dcf
Sum $m 21417.4 19213.3
Net Debt $m 1761.2 1761.2
19656.3 17452.2
Shares on issue m 746.1
Per share value $26.35 23.3912
Current price 41
Discount/prem -56% -75%

As we can see there, Starbucks is trading at a huge premium (note, WACC is taken from here); the growth figures I have used are fairly generous to help prove my point.

I have also used Benjamin Graham’s formula to show the expected price, as per Jae Jun’s version of this formula.

Company Stats
Normal Earnings $ 0.91
Expected 5 Year Growth 10.00%
20 yr AA Corp Bond Rate 6
Company Valuation
Per Share Value $ 19.76
Desired MOS 66.00%
Purchase Price $ 34.00
Current Price $ 41.00
Actual Discount 0%
prem/disc -72%

For more on Graham’s formula see here.

Summary

So what do the numbers tell us? Even on very generous growth esimates, Starbucks’s current price appears way too expensive.

I think that a short play is in order due to the following reasons:

  1. Current market turmoil may mean that expensive/consumer discretionary stocks may sell off
  2. Coffee drinkers are fast changing their preferences away from mass-produced coffee
  3. Starbucks’ recent announcements to expand via acquisitions may see capex increase dramatically
  4. It does seem incredibly overpriced

Disclosure: I am short Starbucks

Source: Starbucks Is One Expensive Cup Of Coffee