bruce Anane
Starbucks Corp (NASDAQ: SBUX) is the market leader in retail coffee sales. The company developed its business model from its first store in Seattle and expanded to the United States and then internationally. Today, Starbucks remains popular among consumers and investors. At the right price and valuation, we consider Starbucks a long-term buy.
No other coffee stock has the marketing potential and brand strength of this one. We also believe that the dividend will continue to grow, but at a slower pace. However, investors may want to wait for a better entry point.
Overview of Starbucks
Starbucks was founded by Howard Schultz in 1971 in Seattle. From a small store, it has become the largest coffee chain in the world. Starbucks went public in 1992. By the end of the second quarter of 2023, Starbucks will have approximately 37,222 stores. About 16,144 stores were located in the United States and 6,480 in China. Starbucks owns about 51% of its stores, and 49% are licensed.
Starbucks sells coffee, coffee-based beverages, other beverages, pastries, breakfast foods, and lunch meals in its retail and licensed stores. The company also sells coffee beans, ground coffee, and coffee-based drinks in grocery stores through a partnership with Nestlé. Starbucks, Teavana, Seattle’s Best Coffee, Evolution Fresh, Ethos, Starbucks Reserve, and Principi are the main brands.
Total revenue was $30,232 million in 2022 and $33,077 million in the following twelve months.
Selected Data for Starbucks (NASDAQ)
|
Anchor |
Category |
|
Market Cap |
$109.36 billion |
|
Stock Price |
$95.48 |
|
Dividend (FWD) |
$2.12 |
|
Dividend Yield |
2.22% |
|
P/E Ratio (FWD) |
27.28X |
Source: Portfolio Insights data (as of August 26, 2023)
Starbucks’ Dividends and Dividend Safety
Starbucks started paying increasing dividends 13 years ago, making it a serious contender. The company quickly increased its payments. The five-year growth rate is approximately 13.8% CAGR, and the ten-year rate is even higher at ~18.7%. However, the annual percentage increase is decreasing due to the high payout ratio.
The forward dividend rate is $2.12 per share, resulting in a dividend yield of approximately 2.22% at the current stock price. This value is higher than the five-year average of 1.99% due to the decline in the stock price over the past year. But it is higher than the average yield of the S&P 500 index.
Starbucks has acceptable dividend safety measures in terms of earnings, free cash flow (FCF), and debt. However, investors should be aware that the stock has been under pressure over the years.
The forward earnings payout ratio is about 68%, which is slightly higher than our target value of 65%. This translates to an annualized dividend rate of $2.12 and a consensus earnings per share of $3.45. Despite a higher valuation than desired, consistent revenue and profit streams should allow Starbucks to pay a dividend.
In addition, the dividends are covered by FCF but could be better. Over the past twelve months, FCF was approximately $2,983 million. Dividends required $2,387 million, resulting in a dividend/FCF ratio of about 80%. Our desired threshold is 70%, so FCF needs to improve to meet our criteria.
Starbucks has consistently increased its debt and leverage since around 2018. As of the end of the second quarter of 2023, Starbucks had approximately $3,620 million in cash, cash equivalents, and short-term investments on its balance sheet. Additionally, the company had $35 million in short-term debt, $1,836 million in current long-term debt, and $13,544 million in long-term debt. As a result, the leverage ratio is now 2.24X, and interest coverage has fallen to 9.5X. While these values are not terrible, they are worse than in the past.
However, Starbucks has an acceptable investment-grade credit rating of BBB+/Baa1 low-medium. The dividend quality rating is « B+, » but mainly due to a weaker balance sheet than a few years ago.
Competitive Advantage and Risks
As the largest coffee retailer, Starbucks has several competitive advantages. Its size and scale give it cost and supply chain efficiency. Small businesses cannot easily replicate the company’s purchasing power. Furthermore, Starbucks has successfully demonstrated that its business model can scale globally, allowing the company to add stores. Lastly, Starbucks has a strong brand presence and marketing. According to Interbrand, this company is among the top 100 global brands. With the strength of the brand and the quality of the coffee, Starbucks can sell its products at a higher price.
From a risk perspective, Starbucks faces significant competition as barriers to entry are low. Additionally, coffee is a commodity, and prices could increase, thereby reducing margins. Similarly, other inputs such as milk, half-and-half, paper products, and labor are sensitive to inflationary pressures. Ultimately, Starbucks products are discretionary. During economic difficulties, customers may switch to cheaper brands.
Valuation
Starbucks trades at high valuations with a price/earnings (P/E) ratio above 27X. However, due to past growth and expectations, this value falls within the 5 to 10-year range. That being said, high inflation combined with price-sensitive customers may mean that current valuations are too high.
Disclosure: long sbux.
Disclaimer: The author is not an investment advisor or a licensed or registered broker. He does not provide personal investment advice. Please consult a licensed investment professional before investing your money.
Author’s Biography: Prakash is the founder of Kolli.
