This was a fun assignment during a Financial Management course analyzing a stock and sharing a report on your findings.
I. Executive Summary: The following is an analysis of the publicly traded Starbucks Corporation known by the ticker symbol, SBUX and referenced to as Starbucks in this document. We have taken an analytical approach to both the stock valuation and firm valuation. In our findings, the Sharpe ratio shows that Starbucks is currently outperforming the market even after risk adjustment. Through further analysis between financial performance, stock performance, and firm performance compared to both the overall market as well as industry-specific competitors we will conclude with a recommendation as to whether or not we believe one should purchase the SBUX stock while understanding external and internal risk factors. As a contingency on our recommendations, we acknowledge that Starbucks is exposed to risks from global trade as well as from a possible change in the economic situation and acknowledge that we have only estimated on a 5-year projection basis which limits our ability to predict further than a 5-year holding period.
II. Business and Environment: Starbucks is traded publicly under the stock ticker SBUX. They are a service company operating in the specialty eateries industry. Opened in 1971, in Seattle Washington, Starbucks holds a current mission statement as being, “to inspire and nurture the human spirit – one person, one cup, and one neighborhood at a time” (“Company Information”, 2019). The company officially incorporated as Starbucks Corp. in 1985. (Russell, 2019).
Starbucks has four different reportable operating segments: Americas, China / Asia Pacific, Europe, Middle East, and Africa, and Channel Development. In addition to its Starbucks Coffee brand, Co. sells goods and services under the following brands: Teavana, Seattle’s Best Coffee, Evolution Fresh, La Boulange, Ethos, Starbucks Reserve and Princi. Co. (Russell, 2019). As of September 2018, Starbucks employed 291,000 employees full time with 18,100 shareholders as of November 2018 (Russell, 2019). Starbucks is the leading player in the out-of-home coffee market, capturing a market share of 39.8 percent. Its largest competitor is Dunkin’, owned by Dunkin’ Brands Group Inc. who holds a current market share of 21.9 percent (“Market share of the leading coffee chains in the United States as of October 2019, by several outlets”, 2019).
Strengths: Starbucks holds a strong brand image domestically in the United States and is also recognized by international consumers with their locations around the world. They are known for specialty coffee drinks and high-end brews which provide high customer satisfaction. “Starbucks does a great job by making their customers feel that they are important” (Raaker, 2019). They know their customer’s names and who they are. Starbucks knows its customer’s previous orders and Starbucks is always creating fresh and new ideas based on customer feedback (Raaker, 2019). This holds strong brand recognition as well as brand loyalty.
Secondly, Starbucks Holds a stable financial position in the market with a market capitalization of $81 billion. The company has increased its number of stores from 1,886 to 29,324 between 1998 and 2018 (Shama, 2019). Through this secure financial position, Starbucks could strategically acquire additional brands and organizations under the Starbucks Corporation. These successful acquisitions include Seattle’s Best Coffee, Teavana, Tazo, Evolution Fresh, Torrefazione Italia Coffee, and Ethos Water (“What Companies Does Starbucks Own?”, 2019).
Lastly, Starbucks is a powerhouse when it comes to efficiency, strategic planning, and reinvestment strategies. As we see in the analysis of the stock SBUX: Starbucks has a high yield yet low dividend payments. One explanation to this is that Starbucks reinvests its profits in expanding its business in different locations (“Starbucks Announces Strategic Priorities to Accelerate Growth and Create Long-Term Shareholder Value”, 2019). In 2019 alone, Starbucks is opening about 600 stores annually in the USA, or about one store every 15 hours. Starbucks is expanding its business despite intensifying competition from rivals like Chinese coffee chain IPO Luckin Coffee, who recently had a successful IPO (Tenebruso, 2019).
Weaknesses: Although Starbucks has expanded into new markets they have had some setbacks. “Starbucks has high price points that maximize profit margins but reduce the affordability of its products. This internal strategic factor is a weakness because it limits the company’s market share, especially in areas with relatively lower disposable incomes” (Lombardo, 2019). This means that Starbucks limits its consumer access to an upper echelon of income producers in the economy marginalizing their market share. Another weakness with Starbucks is the ease at which their products, offerings, and coffeehouse environment can be imitated. Because Starbucks has a generalized standard and does not have a unique selling proposition, its products and business can be easily replicated.
Another weakness for Starbucks is their publicly known European tax avoidance scandals that have been published in mainstream media. One figure of this is that in 2018, “Starbucks’ UK-based European business paid just £18.3m in tax last year while paying the coffee giant’s parent company in Seattle £348m in dividends collected from licensing its brand.” (Neate, 2019)
On top of tax avoidance, it also became known that “Starbucks struck a tax deal with the Netherlands, allowing the American coffee giant to avoid repaying €25.7m in taxes”(Schreuer & Stevis-Gridneff, 2019). However such negative information, through mainstream awareness, has the potential to change consumer behavior. Europen Union loyalists are proud of their countries and may change their buying behavior when they find out that a multinational American corporation has been avoiding and manipulating the European legal systems to retain their profits in America.
Opportunities: Through analysis, we believe their largest two opportunities are having the ability to expand further in developing markets and differentiate their business channels. In December 2018, Starbucks outlined a growth agenda to expand to deliveries in China and the US using uber eats in America and ELE.me in China as delivery partners. This is another opportunity Starbucks holds is their ability to partner. We have seen this happen in retail chains like Stop and Shop, Harris Teeter, and Target here in America just to name a few. However, in China, Starbucks partnered with Alibaba to create a virtual store. “The virtual Starbucks store will enable an elevated “Say it with Starbucks” social gifting experience. For the first time, in addition to purchasing a digital beverage gift card, a customer can also add on a physical StarbucksTM gift, such as exclusive Starbucks merchandise from the Starbucks small flagship store. Customers can also choose to use “Starbucks Delivers” and an Ele.me rider will deliver a Starbucks handcrafted beverage within 30-minutes. What was previously available across many digital apps, now can be completed within single access to the integrated virtual Starbucks store”(Stories.starbucks.com, 2018). The success in China perhaps opens opportunities to replicate this model in other markets to meet or evolve faster than consumer behavior and needs.
Threats: Even with such a strong brand image and market position Starbucks faces multiple threats with new consumer movements and industry competition. Their competition comes with both boutique coffee sellers which may be family-owned as well as larger low-cost coffee sellers, such as McDonald’s. Because Starbucks menus are easily replicated with basic or standardized recipes they are imitable by smaller coffee cafes which may have a warmer feel than the franchising you can expect at Starbucks. We notice a shift of some consumers going back to supporting these small businesses. Peter Bakerville of Australia states in connection with is coffeehouse success, “Promote a warm, welcoming and friendly environment rather than copy Starbucks’ style of self-promoting visuals, structural sameness, and regimented layouts. Make them feel like it’s a ‘home away from home’ in your cafe with interesting and changing visuals, a variety of seating arrangements, and let the customer alter the furniture to suit themselves”(Rizk, 2016). Secondly, on the other end, large coffee outfits or other fast-food chains are capable of offering similar or the same service and drinks which Starbucks provides to their consumers sometimes at a lower price. Starbucks must learn to truly maintain and retain brand loyalty to prevent its current customers from switch loyalty to another coffee provider.
III. Risk and Return Analysis / Sharpe Ratio: The Sharpe ratio is commonly used as a means of comparing an investment performance to a risk-free asset, after adjusting for its risk. This allows investments of different profiles to be compared. The formula to calculate the Sharpe Ratio = RP – RFP where RP is the return of the portfolio, rf is the risk-free rate and pis the standard deviation of the portfolios excess return, concerning the stock. Which is then compared to the risk-free rate, in this case, SHY (iShares Barclays 1-3 Year Treasury Bond ETF, Table 3).
If we compare the Sharpe ratio of SBUX to the market Sharpe ratio both based on the data of the last 5 years, we will get a risk-adjusted performance comparison. This comparison (Table 4) shows that Starbucks with a ratio of 0.91 outperforms the market proxy SPY (SPDR S&P 500 ETF, Table 2) which has a ratio of 0.77.
IV. Capital Asset Pricing Model: Capital asset pricing model (CAPM) is a formula for calculating the expected return on an investment considering its risk. Considering CAPM, the average return of the asset should be correlated to its beta. The formula for CAPM = rf + (rm – rf)where rf is the risk-free rate (Table 7), is the beta and rm is the return on the market. rm is the market proxy SPY (SPDR S&P 500 ETF). A simple linear regression was calculated to predict the excess returns of the investment (SBUX) against the market (SPY) excess returns (Appendix 1). The dependant variable is the investment return (SBUX) and the independent variable (SPY) is the market return. In our regression analysis, SBUX has a beta = 0.49 (Table 6). This implies that for every 1% that the market (SPY) fluctuates, our investment (SBUX) moves 0.49%. To validate our model and confirm our findings, we can perform three validation tests, these include the F-test, t-test and validating the probability value (Appendix 1).
For the F-test, F Calculated (2.238) is >= F Critical (1.54), so we can reject the null hypothesis that the R2 = 0, and the variances of the two populations are unequal.
Our next step is to validate that each independent variable and its relationship to the dependent variable. Comparing the t Calculated (2.65) value versus t Critical (1.672) value, we can reject the null hypothesis, calculated at the 95% confidence interval. The third and final test is validating the p-value (probability). If the absolute value of the P-value is <= 0.05, we can reject the null hypothesis that = 0 and is irrelevant in calculating the expected return. In this case, our P-Value falls below the threshold of 0.05, or confidence equal to or above 95%. This implies the variable is relevant in our model and calculation and the excess market return does have explanatory power calculating the excess return of SBUX. (Appendix 1)
Considering the findings that the model does have validity, we can see that SBUX is less volatile than the benchmark of the market (SPY).
V. Stock valuation: To evaluate SBUX we must look at the non-constant growth model as Starbucks has experienced variable growth periods as well as variable dividend payments preventing us from utilizing the Gordon Growth Model. In our example, we use CAPM as the cost of equity and calculate that WACC for SBUX is 5.48 (Table 8). To calculate CAPM, we needed to estimate the risk-free rate and the market risk premium rate. (Table 7). In our example, we used the non-constant growth model to estimate the intrinsic value of the stock SBUX per share as being $133.75 after a holding period of 5 years (Table 9). To calculate this we use a supernatural growth estimation known as H-Model which we taught ourselves for the first four years of the stock holding period. Then we utilize a required rate of return of 5.83% and discount the value of the stuck and sum of the dividends throughout a holding period of 5 years to understand the present value of a stock. We assume that Starbucks will grow for approximately another five years and then their supernatural growth with level off to a rate of 4.03%. Throughout the five-year growth estimation, we estimate the following non-constant growth rates utilizing the annual 2019 dividend payment and the annualized dividend growth rate for 2019 compared to 2018. The rates we computed were, 19.38% in 2020, 15.55% in 2021, 9.79% in 2022, 5.47% in 2023 and then down to a constant growth rate using the Gordon growth model formula to compute a rate of 4.3% in 2024 (Table 9).
VII. Weighted Average Cost of Capital: The weighted average cost of capital (WACC) is a calculation of the firm’s cost of capital where each category of its capital sources is weighted proportionally. This includes common stock, preferred stock, bonds, and any other long-term debt. A firm’s WACC matters because as the beta and rate of return on equity increase so do WACC, this implies a decrease in valuation and an increase in risk. The formula to calculate WACC = EV*Re + DV* Rd * (1 – Tc)where Re is the cost of equity, Rd is the cost of debt, 100,892 (E) is the Market value of the firm’s equity, 11,167 (D) is the market value of the firm’s debt, 112,059 is the Total market value of the firm’s financing (E + D), 90 % is of financing is equity and 10 % is financed by debt and finally, Tc is the corporate tax rate. In our example, we use CAPM as the cost of equity and calculate that WACC for SBUX is 5.48% (Table 8). This number helps to understand how much interest a company owes for each dollar it finances. Also, the average financing interest cost WACC provides, the company can then use this figure internally to make investment decisions for projects, acquisitions or any other capital outlay. Investors can use WACC as a hurdle rate to indicate return performance on invested capital.
VIII. Firm valuation: To evaluate the firm value and stock value for SBUX we had to use the non-constant growth model to estimate the intrinsic firm value, and then back out the intrinsic stock value per share. Therefore, we assumed that Starbucks keeps growing at a non-constant growth rate for at least 5 years as demonstrated by our model (Table 9). After this period, we believe the stock will grow at a constant 4.30% dividend growth rate after year 5. At year 5 we estimate an intrinsic stock value of $133.75. Compared to other firms of its kind Starbucks is operating at a higher EV/EBITDA than competitors. Currently, the average EV/EBITDA ratio is 19.36. However, Starbucks has a 19.69 ratio meaning that Starbucks is perhaps overvalued compared to its competitors (Table 10). Also, In utilizing Free Cash flows in 2019 and a free cash flow annualized growth rate since 2014 of, 12.63% we get a negative firm value of $53.64 Billion and preceding this, the equity value of $64.8B. All these signals, that the firm will need to raise or earn new equity, not necessarily immediately (Table 11).
IX. Risk analysis: Starbucks is subject to various risk factors, such as global trade as well as the overall economy and competitors. Starbucks is economically selling a luxury good. Therefore, if the economy goes into recession Starbucks sales may fall. Moreover, Starbucks is selling coffee and depends on imported resources to produce its products. Due to this, global trade has a significant influence on the Starbucks supply chain and its cost. Therefore, the company depends on stable import conditions from Africa, South America and Asia (Starbucks Coffee Company. (2019)).which could be affected by local and global politics and natural disasters, such as severe weather. Lastly, Starbucks is in a very competitive market. One wrong move from Starbucks, one innovation that customers do not like and Starbucks could lose market share to its competitors. Overall, Starbucks is doing a good job keeping up with the demand and desires of its customers and benefits from a stable world coffee supply market. Nevertheless, should a recession come Starbucks will be in a business sector that will be hit hard, this needs to be kept in mind when investing in Starbucks – so that this risk can be addressed by proper diversification. However, the risks to the supply chain of Starbucks and its consequences on the income statement of Starbucks are much more unpredictable and much harder to address with diversification. Nevertheless, Starbucks is a good investment that is still in the growth phase which means it doesn’t grow at a constant rate yet. This needs to be kept in mind when investing in SBUX because it holds the risk of becoming stagnant in growth or even declining.
Recommendations: We have concluded based on calculated analysis that Starbucks traded under the SBUX ticker symbol is a wise buy investment in its current market position. With its low beta, it is a relatively safe or less risky investment compared to the current market (table 6). At a lower beta typically traditional thinking means that the stock should yield lower returns. However, in SBUX’s current supernormal growth phase they are outperforming the market with a dividend growth rate of 12.88% in 2019 (Table 9) and has a risk-adjusted return of .91 (Sharpe Ratio, Table 4). With our data, we also find that SBUX has an annualized average return of 21.78% in the prior five years. With these findings, we believe you should actually hold SBUX in a diversified portfolio to protect you from risk we mention under IX. To hold the stock for more than our five-year holding estimations is outside our analysis in this work and would require further investigation to be able to determine a sales point in which we think that the SBUX will have reached its peak performance before its growth rate and fluctuations truly come to meeting market averages.
Appendices, Tables and Figures:
Table 1. SBUX – 60 Month, Annualized Average Returns
Table 2. SPY (Market Proxy) – 60 Month, Annualized Average Returns
Table 3. SHY (Risk Free Proxy) – 60 Month, Annualized Average Returns
Table 4. Sharpe Ratio of SBUX and SPY
|SBUX Average Excess Return Annualized||16.63%|
|SBUX Excess Return Std Dev Annualized||18.26%|
|Sharpe Ratio of SBUX||0.91|
|SPY Average Excess Return Annualized||9.60%|
|SBUX Excess Return Std Dev Annualized||12.53%|
|Sharpe Ratio of SPY||0.77|
Table 5. Market Risk Premium
|SHY Average Return – Annualized||1.11%|
|SPY Average Return – Annualized||10.71%|
|Market Risk Premium||9.60%|
Table 6. Beta
|Beta from Linear Regression||0.4916189873|
Table 7. Capital Asset Pricing Model (CAPM)
|Risk Free Rate||1.11%|
|Market Risk Premium||9.60%|
Table 8. Weighted Average Cost of Capital (WACC)
|Book Value of Debt||11167|
|Weight of Equity||0.90|
|Weight of Debt||0.10|
|Cost of Equity||5.83%|
|Cost of Debt||2.96%|
Table 9. Stock Valuation via DDM and Non-constant Growth Rate
|Dividend Payed||Dividend Growth Rate|
|Expect Dividend||Expected Div Growth||PV of Dividend/Stock|
|Terminal Value of Stock after 5 years||164.38||123.82|
Table 10. Stock Valuation via market multiple analysis
|SBUX P/E Ratio||31.25|
|Market P/E Ratio||23.24|
|SBUX with Market P/E Ratio||67.8608|
|Implied Value of SBUX||$106,947,450,000.00|
|Dunkin’ Brands Group Inc||19.29|
Table 11. Firm/Stock Valuation via Free cash flow approach
|Free Cash Flow|
|FCF 5 year annualized growth rate||12.63%|
|Stock Value per Share||-$52.27|
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