For those who thought Starbucks (SBUX) was finished after its decade-long emergence as a market saturator, think again. The company has once again excited investors while leveraging the strength of its existing brand. As an IR consultant, I see strong potential for under-followed firms Artisanal Brands (AHFP.PK) and Sino Agro Foods (SIAF.OB). These two companies are significantly undervalued and are ready to take off when press coverage improves. We plan on writing favorable focus pieces on them shortly.
Meanwhile, Starbucks will get a disproportionate amount of attention. In this article, I will run you through my DCF analysis on the company and then triangulate it with an exit multiple calculation and a review of the fundamentals compared with Green Mountain (GMCR) and Kraft Foods (KFT). I find that the company is fairly valued.
First, let's begin with an assumption about revenue. Starbucks finished FY2011 with $11.7B in revenue, which represented a 9.3% gain off of the preceding year. Analysts model a per annum growth rate over the next half decade. In my view, this is overly optimistic since it is around 800 bps higher than what is expected for the S&P 500. But, for the sake of demonstrating my point, I accept the projection.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures and taxes. I model cost of goods sold to trend from 73.5% to 72.5% over the next few years largely as a result from a shift toward supermarket business. I further model SG&A at 5.3% of revenue versus 4.3% for capex. Taxes are estimated at 33% of adjusted EBIT.
We then need to subtract out net increases in working capital. This figure is estimated to hover around 1% of revenue.
Taking a perpetual growth rate of 2.5% and discounting backward by a WACC of 10% yields a fair value figure of $53.10, implying that the market is correct. This is also around the price target.
All of this falls within the context of improving momentum:
Q1 was an outstanding quarter for Starbucks on many levels. We served more customers in our stores around the world than at any other time in our history, and our financial performance indicates that we delivered on every key performance metric, to drive our ninth consecutive quarter of positive comps, including 9% growth in U.S. comparable store sales and 9% increase in global comparable store sales, a 7% increase in customer traffic and the strongest holiday season in our 40-year history, record quarterly revenues of $3.4 billion and record quarterly earnings of $0.50 per share.
From a multiples perspective, Starbucks appears overvalued. It trades at a respective 33.3x and 24.2x past and forward earnings. When the economy hits full employment, these figures are not likely to budge much higher. On the other hand, Green Mountain trades at a respective 27.9x and 14.7x past and forward earnings versus 19.2x and 13.7x for Kraft. Assuming a multiple of 25x and a conservative 2012 EPS of $2.22, the rough intrinsic value of Starbucks' stock is $55.50.
Consensus estimates for Green Mountain's EPS forecast that it will grow by 56.1% to $2.56 in 2012, and then by 40.6% more in the following year. Assuming a multiple of 20x and a conservative 2012 EPS of $3.49, the rough intrinsic value of the stock is $69.80, implying around 30% upside. Keurig single-cup coffee makers have demonstrated strong demand, but the company faces significant competitive pressures in K-Cups where Starbucks is growing. The company is still relatively safe with around 20% lower volatility than the broader market.
I anticipate significant upside for Kraft. It is led by top management that understands the ins and outs of everything food. In 2011, the company's Power Brands grew 8% and it delivered solid execution despite skyrocketing input expenses and political instability. Assuming a multiple of 17x and a conservative 2013 EPS of $2.74, the rough intrinsic value of Kraft's stock is $46.58.
Additional disclosure: We seek IR business from all of the firms in our coverage, but research covered in this note is independent and for prospective clients. The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.