Download an Excel model for optimistic and aggressive revenue and margin assumptions.
There are not many companies in which nearly every fundamental
metric we look at is improving across the board. But they do exist, and one such impressive
company is Starbucks Corp (SBUX). Given our preference for highlighting stock
ideas that show good value against sustained operating momentum, we would
prefer portfolio managers wait for a better price before purchasing, closer to $17-19 or at most
at 15.2x the consensus FY2011 EPS estimate of $1.25.
Such a purchase price would allow participation in a possible resurgent
growth story without being too aggressive. Our blended scenario analysis 12-month target is $23. More optimistic target valuations are plausible, but require more conviction than we are comfortable with at the current time.
There are not many companies in which nearly every fundamental
metric we look at is improving across the board. But they do exist, and one such impressive
company is Starbucks Corp (SBUX).
At the current level, SBUX is a good option for growth
investors that expect significant upside to current consensus forecasts –
because we do think there is some chance of this occurring. SBUX is also currently a good stock idea for
high turnover portfolios driven by constantly updated relative value decisions,
such as the Ascendere Long/Short Model Portfolio. But given our preference for highlighting stock
ideas that show good value against sustained operating momentum, we would
prefer portfolio managers wait for a better price, closer to $17-19, or at most
at 15.2x the consensus FY2011 EPS estimate.
Such a purchase price would allow participation in a possible resurgent
growth story without being aggressive.
Our target 1yr value is $23, which is below the consensus
average target of $25 and derived from a scenario analysis indicating a
realistic valuation range of $9-46. For
the stock price to reach near the high end of our range, we think the company
would have to generate EPS approaching $1.70 in fiscal 2011 and show
accelerating growth beyond. In contrast,
the consensus SBUX EPS estimate for FY2011 is $1.25 and the consensus high is $1.41. While these optimistic scenarios are
aggressive, they are also plausible under perfect conditions.
Bucking the trend
We took a quick look at Starbucks Corp. in early 2009, and as generalists
searching for the best relative opportunity among 3000+ stocks that trade on
major U.S. exchanges, were not impressed.
Fundamental metrics were trending poorly, international markets were in
full fledged recession, and a premium-branded coffee and related items seemed
like easy things for the consumer to give up in the quest for newfound
frugality. New initiatives announced
upon the return of Starbucks' founder Harold Schultz to the CEO role in January
2008 did not seem to be having a measurable effect. The stock peaked close to $40 in December
2006 and traded as low as $7 in 2008.
But March 2009 results marked the turning point. The cumulative effect of new initiatives focused
on controlling operating costs, improving operating efficiency, strengthening
connections among customers and the closure of 900 stores and lay off of 700
employees have translated into significant operating momentum which seems
likely to continue through 2010 and perhaps beyond.
Impressive operating momentum since early 2009
Since the end of 2008, Starbucks has seen a significant decline in
capital spending, operating capital has been reduced, and various measures of
profitability and cash flow have drastically improved.
In more detail, since December 2008 Starbucks
has reduced estimated Operating Capital by $1.6b to $6.9b from $8.6b, while
estimated adjusted operating profit has improved more than 3x to $762m from
$211m over the same period. Anyway you look at it — EBIT, adjusted EBITDA,
free cash flow — profitability has surged since December 2008 while the amount
of capital required to create this profitability has declined.
This has helped the company generate a ROIC
higher than its cost of capital for the first time in several quarters. In addition, this has put $700m+ in cash on
its balance sheet bringing the total to $1.4b cash and short-term
investments. In the most recent
conference call the company said it expects to conclude work on a distribution
strategy for this excess cash in the coming months. Starbucks' December 10, 2009 presentation provides some additional detail.
Starbucks learned valuable lessons in its domestic market
CEO Harold Schultz summarized the recent improvements during Starbucks’ January 20, 2010 conference call transcribed by Seeking Alpha for the fiscal
first quarter that ended on 12/27/2009:
“This was a very satisfying quarter by any standard and follows three
successive quarters of continued improvement in our business. Our U.S.-company
operated stores reached a significant milestone in Q1 as all regions reported
positive comp growth and our U.S.-licensed stores also delivered strong
results. As in prior quarters, our business this quarter benefited mightily
from continued innovation from the success of our company wide efforts to
improve customer experience from our continued laser focus on controlling
operating costs and improving operating efficiency and from the impact of
decisive actions we took early in 2008.”
not a surprise that SBUX stock has seen a rally of 165% from a March 2009 low of $8.27
to a recent close of $21.91, outperforming the S&P 500 return of 56% and
the S&P Discretionary SPDR (XLY) return of 78% over the same period. If estimates are revised further upward,
there could be more room for SBUX to move.
Upside possible if company executes flawlessly and if global economies improve
We find the current consensus estimates that imply continued
improvements for ROIC and solid earnings growth believable and perhaps
containing some potential to move even higher, which makes us comfortable with
not overly-weighting a negative valuation scenario. The company seems to have learned some
valuable lessons in its U.S. market, and has recently started increasing
marketing spending to drive revenue on some key growth platforms and
initiatives like new types of Starbucks Cards. It is also increasing
investment in its well-received VIA instant coffee product and on efforts to "refresh"
the designs of existing Starbuck stores.
In addition, the company intends to apply the lessons learned in the
U.S. to international markets. For now, international
efforts appear to be concentrated in the U.K., France, Spain and China.
Starbucks believes China will become its largest market outside of the
U.S.
If Starbucks can drive revenue in
China and other international locations to one-half to two-thirds of the level
of growth experienced in its early growth phase in the United States, there
could be significant upside to consensus revenue and earnings growth forecasts.
Relative valuation summary
Starbucks is currently trading at 20.2x NTM consensus EPS of $1.12
versus a 5yr average of 26.8x and a range of 10.1-53.4x. Fifteen sell side analysts provide targets
ranging $13 to $30 and average $25.
Nineteen sell side analysts provide FY2011 EPS estimates ranging from
$1.15 to $1.41 and average $1.25.
On a relative EV/EBITDA basis, SBUX trades at a slight discount to a
peer average, and on a PE basis it is at a premium. Given its high growth prospects and ROIC
profile, these multiples are justifiable and actually offer a slightly better
adjusted value at this snapshot in time — but they do not point to an
overwhelming bargain.
Scenario analysis
We have chosen 4 different scenarios in which to value Starbucks. Numerous underlying factors can be summarized
in the long-term earnings growth rates on a 10% WACC and 2.5% terminal growth
rate — 21%, 18%, 8% and negative 3%. A
more aggressive 9% WACC and 3% terminal growth rate may be justifiable, and
could positively impact our range of targets by about $1-10.
- The most realistic but conservative assumption
in our opinion is the 8% growth scenario, which suggests the stock deserves to
trade at only about 17x the consensus NTM EPS estimate of about $1.12 or at
about $19 one year from now. - But If SBUX can beat and raise estimates
throughout the next two years and get on track to close to 18% earnings growth
on average for the next 5 years and moving higher beyond that, perhaps the
stock should be more appropriately valued at $30, or about 18x an
above-consensus-high FY2012 EPS estimate of $1.70. We are comfortable with these assumptions for
this particular scenario because we think they reflect the possibility of
continued operating momentum and a growing penchant for China and other
countries to embrace a number of American brands
- A $46 stock price target is justifiable under
the right conditions, though a bit farfetched at the moment. Such a target would have to assume flawless
execution, faster than anticipated international expansion and a rebound in the
global economies so that the company could resume a growth rate seen 5 to 10
years ago. True believers would have to
justify a target earnings growth rate of 21% compounding to $2.80 by FY2015 and
accelerating at a higher rate beyond. - If Starbucks runs into additional problems or
the economies falter again so that earnings essentially decline 3% on average
over the next few years, a fundamentally justifiable target could be $9 today.
Simple Microsoft Excel models for SBUX revenue growth and operating
margin assumptions that we used to help generate realistic scenarios for
optimistic earnings growth are available at our website www.ascenderellc.com.
The current stock price embeds assumptions for continued operating
momentum that can drive consensus estimates higher. While that is possible, we recommend waiting
for a pullback to the $17-19 level before purchasing this stock. Using a most likely possible target range of $17
to $30 by next year does not provide an overwhelmingly compelling risk/reward
with the stock at $22. However, for the
portfolio manager that is required to purchase a Consumer Discretionary stock
immediately, or is managing a portfolio with high turnover in which decisions
can be quickly adjusted (such as the Ascendere Long/Short Model Portfolio), SBUX
in our opinion is the best idea at the moment.
Our current estimated stock price target for SBUX is $23, which is outlined
in the table below.We are aware of our seemingly contradictory recommendation — that on a
relative basis SBUX is slightly more attractive but on a standalone basis is less
so. This raises two basic questions
though with very large implications: Is SBUX or even the entire Consumer Discretionary sector is embedding overly optimistic assumptions on a
global economic recovery? Or will SBUX and other discretionary stocks in retrospect confirm our past observations that in general sell side analyst
estimates lag the market rather than anticipate it? Our intuition is that it is probably a little bit of both; further analysis on this subject deserves our attention.
Risks
While every effort is made to do so, Ascendere Associates LLC can makes no guarantee on the accuracy of the
data, estimates, assumptions or forecasts in this report. Investing in SBUX or any equity entails a
high degree of risk, including the risk of total loss. This report is not a solicitation to buy or
sale any securities.
