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My investing philosophy mostly centers around the Value discipline and GARP- Growth at a Reasonable Price. This blog includes commentary on market conditions as well as fundamental analysis of specific companies. Graduated from Rhodes College with a degree in Business with concentration in Finance & Marketing. Currently working on obtaining the CFA designation. Previously worked in Mortgage Trading for a major bank. Use MS Excel extensively for developing investment models, notably valuation models based on DCF methods.

Monday, February 11, 2008

Starbuck's Valuation: A Few Thoughts


Starbuck’s Coffee (nasd: SBUX)- Discounted Cash Flow Valuation: $23


Starbuck’s stock has been getting a beat-down for more than a year already, down more than 50% from the $ 40 high reached Nov ’06. In the past few months, SBUX fell from the $ 26-28 range where it was treading water all summer into the fall. Now, trading around $18, SBUX is still not cheap. Applying a discounted cash flow model gives a fair value estimate of $23. 

Even though fair value exceeds current price by a decent amount, the margin of safety is too small given Starbuck’s negative momentum and expected near-term weakness. However, for a long-term investment horizon (10yr+), I believe SBUX can be bought here. However, Starbuck’s may have rough time in the near-term.

Last August, I placed a value on SBUX of $35 /share. SBUX announced it is scaling back store additions for the coming year, thus I slashed my sales growth forecast resulting in the steep drop in valuation. Projected 5 year growth rate assumption decreased from 18% (aug) to 14%. The other input assumptions really didn’t change, just the revenue growth projection. Read SBUX: Long-term Hold

The last 5 years, SBUX sales growth averaged 23.5% fueled primarily by new store additions. Starbucks cut its previous forecast for 2008 new stores from 1,600 to 1,175 (US), plus mentioned closing 100 or so underperforming locations. The company is forecasting ’09 US store additions of less than 1000. Slower/less growth in Starbuck’s store count translates into less revenue in future periods.

Fear of slowing growth is the main culprit to Starbuck’s stock price slide. Concerns that a slowing economy will materially affect SBUX might be discounted in the share price, but SBUX is well insulated and recessions are short-lived events. Stocks are valued over a long-time horizon, at least 50 years. Worries about McDonalds giving SBUX a run for its money are laughable. Yes, MCD may negatively impact Starbuck’s growth, but only slightly, if at all. I believe that new store expansion has been too aggressive, causing cannibalization of store traffic. Aware and addressing this issue, Starbuck’s is scaling back store openings. Read SBUX Face-off

Foot traffic at comparable stores declined (or was flat) for the past several quarters, leading me to suspect sales cannibalization. Some geographies likely became over-saturated, thus a new store takes traffic from an existing, causing weak SSS comparisons. Surely, some customers who constituted the sales at new locations had visited a SBUX in the previous year. Take a person who had 20 store visits last year. This year that customer returned 10 times to that location, but also went to newly opened store on other ten occasions. That’s where the foot traffic is going, to the 1,800 stores opened this year. Read SBUX Cannibalization

Last fall, management maintained saturation played no part in declining foot traffic as concerns rose. The Reduction to planned store openings is an admission that cannibalization is becoming an issue. On the last call, the CEO said they were slowing down store additions to avert sales cannibalization of existing locations. So, it is problem, the primary problem, not the MCD noise or economy fears.

I think SBUX still has significant growth potential, albeit at a slower pace. SBUX still has some room to grow domestically and plenty of room internationally. Management needs to be more deliberate about expansion, instead of shooting from the hip putting stores any & every where.

Starbuck’s generates high returns on capital and equity. Usually competition and market forces drive returns down to a more normal rate, yet Starbuck’s possesses a very strong competitive position that will keep returns above normal for a considerable time. These factors underlie premium multiple that investor’s have placed on SBUX.

Examining Starbuck’s market valuation from price/earnings vantage point also suggests that shares are fairly-valued. Maybe slightly undervalued, maybe. Certainly not undervalued or cheap by any means.

SBUX is trading at 19x Sep FY earnings and 16x next year’s estimate. Using ValueLine and Nasdaq.com for estimates years farther out, I calculated my 5-year growth rate projection of 15%, not 19% analyst consensus estimate. 13-15% growth may not warrant a 19 multiple, but given ROI and the persistence of growth and competitive advantages, SBUX trades at a reasonable multiple. Interest are very low too, making a case for higher P/Es.

One area of concern is the downward trend in revisions to EPS estimates, which may portend even more downward revisions.


Earnings Estimates and Revisions:


Starbuck's Historical Data:


SBUX Valuation: Discounted Cash Flow Model

4 comments:

john said...

recessions are not always short term events.

many economists may not fully appreciate how large the downside risks are, granted, risks to the upside are large too if the intereventionsists win one for the gipper.

Turley M Muller said...

John,
I would say its how one defines short-term. My idea of short-term is up to 2 years, but mostly 6m-12m, I would say.

Historically, and I stress historically, duration of recessions are:

Since WWII 10m long (10)
Since 1990 8m (2)

But, the past is not the future, and I totally agree that downside risks are not appreciated fully.

Intervention can help avert or assuage downturns, but I also think that there is the latent risk of screwing it up really bad. There more you mess with something, there is the risk of un-intented consequences, like invasive surgery.

I don't know if many are aware of that. But, if the Fed and Congress can get it right, get lucky, then any natural growth will be leveraged.

Check out table of business cycles

ECONOMIC CYCLE TABLE

scott said...

The structured product "age" is being tested....Serious changes will result and hopefully we can find a positive light at the end of this very dark tunnel.

syboo @ FinanceHolic.Info said...

great...!

it's an old info..
but I still love it...

thanks :)

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