Tuesday, July 12, 2011

Is Starbucks Right For Your Portfolio?

Starbucks (NASDAQ: SBUX), the $29.8 billion market capitalization (up 57% in the last year) coffee retailer, announced that it would reorganize to capture global growth opportunities. If that helps the company accelerate earnings growth, it should make the company more valuable. Is now the time to invest?

Starbucks CEO Howard Schultz wants to boost the company's global revenues. Currently 25% of its $10.7 billion in annual revenues come from overseas and Schultz wants that figure to hit 50%. To do so, Starbucks will probably need to add to the 6,000 stores it operates outside North America where it has 11,000 stores. Starbucks hopes to achieve that 50% by growing in China, Brazil and India.

Starbucks has a mixed record with expansion so its success is hardly guaranteed. For example, it added stores during the 2000s and then suffered a big slowdown during the financial crisis. Schultz stepped back in to right the ship and is now focusing on how to accelerate growth.

But global expansion has its challenges. As I pointed out in my forthcoming book, Export Now, co-authored with Frank Lavin, CEOs seeking to boost exports ought to consider the five Cs -- country, customers, competition, capabilities, and closing the capability gap -- before making their global move.

To assess whether Starbucks will succeed with its effort to make international revenues 50% of the total, investors should consider how well Schultz is addressing the following issues:
  • Are the countries that Starbucks targets attractive based on their size and familiarity with its brand?
  • Can Starbucks adapt its product line and service style to the needs of each country?
  • Does Starbucks understand the competition in each country and why customers will chose its products over competitors'?
  • Does Starbucks recognize which of its strengths in North America will help it in those new countries and which might turn into weaknesses?
  • Can Starbucks bolster its weaknesses and get the capabilities it needs to succeed in the new country?
While it is too soon for answers to these questions, here are three reasons to consider investing in Starbucks now:
  • Long-term financial strength. Starbucks has grown steadily. Its $11.2 billion in revenues have increased at an average rate of 11% over the last five years and its net income of $1.1 billion has risen at a 13.9% annual rate over that period. And its cash grew at a 33.7% annual rate between 2006 ($454 million) and 2010 ($1.4 billion). And at a debt/equity ratio of 0.13, Starbucks has little debt.
  • Strong fiscal first quarter earnings that met expectations. Starbucks' net income rose 20.4% from the same quarter of 2010 to $261.6 million. Its EPS of 34 cents/share met analysts' estimates -- while revenue was up 9.9% to $2.8 billion.
  • Out-earning its capital cost. Starbucks earned more after-tax operating profit than its cost of capital and it's improving, Starbucks's EVA momentum which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales was 5%, based on 2009 revenue of $9.8 billion, and EVA that improved from negative $6 million in 2009 to $476 million in 2010, using a 10% weighted average cost of capital.
The problem for investors now is that Starbucks is an expensive stock. Starbucks' price to earnings to growth (PEG) ratio of 1.33 makes it somewhat over-valued (a PEG of 1.0 is considered fairly priced). Starbucks' P/E is 27.8 and its earnings are expected to grow 20.9% to $1.81 in 2012.
Given the volatility in the market related to concerns with Italy's debt and the status of U.S. debt ceiling negotiations, I would not be surprised to see a better entry point for the stock. And if Starbucks can achieve its global growth goals, its stock is likely to provide investors with upside surprise in the medium term.


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