Starbucks Brewing More Growth For Investors

| About: Starbucks Corporation (SBUX)

Starbucks (NASDAQ:SBUX) has been growing healthily, returning over 80% for the past five years compared to single-digit negative returns for the S&P 500 and Dow Jones Industrial Average indexes. In my opinion Starbucks will continue to grow above the market as coffee remains a strong business here and internationally. Starbucks recently started selling K-cup single-cup coffee under an exclusive license for super-premium coffee and Tazo tea with Green Mountain Coffee Roasters (NASDAQ:GMCR). In addition, the company is expanding in India and China, it recently acquired Evolution Fresh juice, and has plans to capitalize on its brand by increasing Starbucks' distribution in grocery stores. All this together with the company's proven management, make the stock an attractive growth investment. While the growth story is good, the company also started to pay a quarterly dividend in April of 2010. Currently, the stock has an annual dividend yield of about 1.2%.

When the deal between Starbucks and Green Mountain Coffee Roasters was announced in March of 2011, shares of Starbucks rose 8% while Green Mountain Coffee Roasters was up 30% in just one day. In this win-win deal, Green Mountain will sell Starbucks's Tazo tea and also the Starbucks coffee will be Green Mountain's exclusive super-premium single-cup brand. In addition, Starbucks will launch a single-cup high pressure system called Verisimo in a partnership with Germany's Krueger. The system together with Starbucks own coffee and milk pods will be available for the 2012 holiday season.

Industry analysis shows that the single-serve brewing coffee is a $2 billion business per year in the U.S. and growing. With its strong brand, Starbucks should be able to gain at least 20% or $400 million in revenues by the end of 2013. Assuming a net profit margin of 15%, this gives $60 million of additional annual earnings. Starbucks has 759 million shares outstanding, so the single-cup partnerships alone will contribute about $0.08 of earnings per share. At a price to earnings ratio of 32, this is an additional $2.56 per share or a 5% appreciation by the end of 2013.

In addition to single-cup coffee serving, Starbucks has been expanding into the juice market. The $30 million acquisition of Evolution Fresh allows the company to offer its own brand in the multi-billion fresh juice market as well as in the larger health and wellness center. Only a few months after Starbucks acquired Evolution Fresh it opened its first location in Bellevue, WA with plans to open more locations in Seattle and the West and East coasts in the next twelve months. I believe this will contribute to earnings per share growth substantially starting in 2013. Evolution Fresh sells juice made by a high-pressure system that retains most of nutrients and flavors in fruits. Also, the store will offer healthy food including vegetarian and vegan choices. Assuming Starbucks gains a 10% share of the $50 billion health and wellness sector by 2015, it will grow its revenues by $5 billion and earnings by $500 million (assuming net income margin of 10%). Thus, this venture will contribute $0.65 in earnings per share per year. At a price to earnings ratio of 30, this gives an additional stock value of $19.5 per share.

In fact, Starbucks entry into the single-cup brew coffee and the health and wellness sector is only one piece of a larger play to leverage the Starbucks brand into the consumer packaged goods sector. Starbucks already has a partnership with Pepsico (NYSE:PEP) to make and sell ready-to-drink beverages which generates $1 billion in revenues per year. Starbucks also owns the Seattle's Best premium brand. This together with the super-premium brand of Starbucks and Evolution Fresh will provide plenty of growth opportunities in the high-volume grocery area. It is too early to estimate the success of this initiative but it should provide additional growth to the company.

Internationally, Starbucks' Indian entry in a joint venture with the Tata Group was announced earlier this year. I estimate that it will have a meaningful impact on earnings per share as early as 2013. India is known mostly for tea, but at the same time there are many local and international coffee chains. I believe that there is space in the second most populated country for the industry's global icon in coffee. Also, coffee consumption should increase as the Indian standard of living improves and due to the strong urbanization process that is still evolving. While Starbucks is just starting its expansion in India, China is expected to become the second largest market in just a few years, trailing just the U.S. The company will move closer to this goal by planning to open an additional 150 stores in 2012 in China.

Starbucks clearly has the financial strength to work on these growth initiatives. The balance sheet has $2.2 billion in cash and only $550 million in long-term debt. In addition, Starbucks generated $575 million in net cash from operating activities for the quarter ending April 1, 2012. Of course the financial strength is backed by an experienced management team that is led by the CEO, chairman, and president of the company Howard Schultz. In addition to leading a company with over $11 billion of annual revenues and 200,000 employees worldwide, recently Mr. Schultz wrote a best-selling book, Onward: How Starbucks Fought for Its Life without Losing Its Soul.

In conclusion, this and next year will be pivotal for Starbucks as it implements its new growth initiatives here and abroad. Its shares currently trade at a price to earnings ratio of 32. Estimates for the financial year end in September of 2012 are for earnings of $1.90 per share. I estimate Starbucks to earn $2 per share this year (helped by decline in the price of green coffee) and $3 in 2013. Assuming a price to earnings ratio of 30 this gives a stock price of $90 or a 58% appreciation from current levels. While this is not a guarantee, I think that investors have a chance of significant capital appreciation in the next few years by investing in Starbucks stock before the outcome of its growth initiatives is certain. In the meantime, investors are paid a dividend yield of 1.2%, which should smooth the volatility of the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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