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Starbucks ($SBUX) is in an interesting position. You would expect premium coffee purchases to be down in the current economic climate. The company has also just raised prices on some beverages. Yet $SBUX is currently trading toward the top of their 52-week range at US$19.35. Time to have a bit of a look.

Valuecruncher Interactive Analysts Report For Starbucks ($SBUX)

The key comparators are Tim Hortons ($THI), a direct competitor, and McDonalds ($MCD), a low-cost substitute.  You can change the generated peer companies on the site.

So what do we think?

Discounted Cash Flow Valuation

We have completed a discounted cash flow valuation using our interactive tools (there is a “discounted cash flow analysis” link just under the company name on the company page). We have populated our model with a mixture of consensus analyst estimates and Valuecruncher estimates. Our analysis produces a valuation of US$11.95 for $SBUX – 38.7% below the current share price. We see $SBUX well overvalued using a discounted cash flow model. But how about compared to a peer group?

Comparison Analysis

I am going to look at two of the metrics we use at Valuecruncher – Enterprise Value (EV)/Revenue and EV/EBITDA. Enterprise Value (EV) is simply market capitalization plus net debt [long-term borrowings less cash]. We use EV to capture the impact of debt and cash on a company’s balance sheet – market capitalization doesn’t capture different capital structures when comparing companies.

EV/Revenue shows how a dollar of revenues is being valued by the market against the comparator set. On an EV/Revenue basis $SBUX is trading at 1.5x ($SBUX is being valued at 1.5x last year’s revenues). This compares to $THI at 3.0x and $MCD also at 3.0x. $SBUX’s profit margins (at the EBITDA line) were 11.6% of revenues last year – against 25.4% at $THI and 31.5% at $MCD.  A dollar of $SBUX revenues is being valued at half that of a dollar of $THI and $MCD revenues – this is broadly in-line with the difference in profit margins in the businesses last year.  This is what we would expect.

EV/EBITDA shows how a dollar of profit (measured in as Earnings Before Interest Taxes Depreciation and Amortization) is being valued by the market against the comparator set. On an EV/EBITDA basis $SBUX is trading at 12.7x ($SBUX is being valued at 12.7x last year’s profit at the EBITDA line). $THI is trading at 11.8x and $MCD is trading at 9.3x. This difference will represent the different expected profit margins and growth prospects between the businesses – as being valued by the market. We are surprised that $SBUX profits are being more highly valued than their competitors. This suggests that the market currently believes that $SBUX’s fortunes are about to improve significantly and some of the gains are already being priced into the stock.

Summary

Based on our DCF valuation – $SBUX looks significantly overvalued. Looking at some comparators we are surprised that $SBUX is being so highly valued (especially on an EV/EBITDA basis) agaist key comparators $THI and $MCD. $SBUX looks a sell at these prices.

Disclosure: no positions.

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This week Starbuck’s (SBUX) announced it was closing 500 US locations and cutting 7% of its workforce. At Valuecruncher we decided to have a look at some projected financial numbers to analyse what this means for the slower brewing coffee giant utilising our on-line valuation tool.

This is the quantitative take on Starbucks – for a qualitative take; Portfolio magazine profiles Starbucks CEO Howard Schultz in this month’s issue.

SBUX Valuation

Starbucks grew revenues from US$5.3 billion in 2004 to US$9.4 billion in 2007 – a 21% compound annual growth rate. Our assumptions of revenues for the next three years are US$10.5 billion in 2008 growing to US$12.5 billion in 2010 – a 9% compound annual growth rate. We have projected EBITDA margins to be flat at 10%. We have used a terminal growth rate of 4.5%. We calculated this terminal growth rate based on year three growth of 8.7% dropping to a 4% stable growth rate by year 10. We used a terminal capital expenditure number of US$800 million. We have used a WACC (discount rate) of 10%.

Valuecruncher Valuation SBUX

Our analysis incorporates the cash and debt on the Starbucks balance sheet – Valuecruncher calculates a net debt number.

Our analysis gives a valuation of US$15.07 which is 4.3% below the current share price of US$15.74.

Based on our analysis the current valuation looks slightly overvalued. Play with our assumptions – what does your analysis say?

Valuecruncher has a database of over 1,000 companies on major international exchanges. You can explore, create and share valuations for any of these companies.

Valuecruncher Valuation Report – Starbucks

Since mid-November Starbucks stock price has dropped from $40 to a 12 month low of $25.22 this week. Contributing factors appear to include the continuing decline in comparable store sales growth from 10% p.a to 8% p.a. over the last 3 years and the lower operating margin in 2006 financial year (11.5% down from 12.3%). The drop in same store sales may be a function of strong competition from existing players including Dunkin Donuts and moves by McDonalds to grow their McCafe brand. Starbucks faces ongoing competition from local niche/gourmet coffee retailers as customers migrate to higher quality products. The declining operating margins reflect the increase in occupancy costs, transportation costs and commodity prices. 

Despite these declining metrics revenues have continued to grow (22% in 2006) as Starbucks pursues an aggressive growth strategy. The Seattle based coffee retailer has over 12,000 stores worldwide with plans to grow to 40,000. In the 2006 financial year Starbucks opened 2,199 stores and plans to open another 2,400 in 2007. Starbucks is focusing on developing the Starbucks Experience; this includes a film partnership, a music label and a book strategy. This strategy may allow Starbucks to extract extra value from it’s customer base and provide a point of difference in an increasingly competitive market. It remains to be seen if the Starbucks Experience will impact on the customer looking for the best value coffee or premium coffee product.

Starbucks’ DCF Valuation

Valuecruncher places a mid-point valuation of $25.04 per share on Starbucks with a sensitivity range of $22.92 to $27.23. The Valuecruncher mid-point is slightly below the current valuation of $25.77.

DCF Assumptions

Revenues are forecast to grow to 13,780 million by 2009 representing a compound annual growth rate of 21% driven by aggressive growth strategy. EBIT margins are forecast to increase slightly to 11.8% (from 11.5%). It is hard to quantify the impact of the Starbucks Experience strategy on profit margins but with approximately 85% of revenue derived from company operated retail store sales Starbucks’ profitability will continue to be driven by occupancy, transportation and commodity costs. Short-term capital expenditure of $1 billion+ p.a is forecast to facilitate the planned expansion. Long-term growth is forecast at 6%, this relatively high assumption reflects the target of 40,000 stores worldwide. Valuecruncher has used a 10% cost of capital for Starbucks.

Comparable Company Analysis

Starbucks is currently trading at a forecast EV/EBIT multiple of 18.1 compared to the Valuecruncher valuation of 17.6, the forecast multiple is used to incorporate some of the short-term growth factored into Starbucks’ valuation. It is difficult to identify a comparable company that operates in the retail coffee market on a similar scale to Starbucks. In North America Dunkin Donuts is a major competitor but it is privately held. Valuecruncher has compiled valuation multiples for Tim Hortons and McDonalds to provide a point of reference but they are not suitable to provide a comparable company valuation.

Tim Hortons

Tim Hortons has over 3,000 in North America and was a wholly owned subsidiary of Wendy’s International until an IPO in March 2006 followed by a complete separation from Wendy’s International in September 2006. Tim Hortons have a forecast EV/EBIT multiple of 15.1 but although they compete directly with Starbucks they are not suitable for a direct comparable company valuation. Tim Hortons does not have the international presence of Starbucks and is not undertaking the rapid expansion strategy of Starbucks (in 2006 Tim Hortons opened approximately 160 stores). The Tim Hortons business model also differs from Starbucks, Tim Hortons franchise out over 95% of their stores compared to Starbucks who generate 85% of their revenue from company owned stores.

McDonalds

McDonalds has developed a McCafe brand that competes with Starbucks in the retail coffee market. Currently the McCafe brand represents a relatively small portion of McDonalds operations limiting the validity of McDonalds as a comparable company. McDonalds has approximately 30,000 stores worldwide and operates in the same geographical markets that Starbucks currently operates in and those it plans to expand into. McDonalds have a forecast EV/EBIT of 13.6.

Conclusion

Based on the DCF valuation the Starbucks’ stock price appears to be an accurate reflection the company’s current value. Starbucks has significant growth opportunities with only 17% of its current revenues being generated outside the United States. Starbucks strategy to grow its international presence is driving the 20% p.a growth forecasts. A market such as China presents enormous potential for Starbucks but developing it has risks and uncertainties. Starbucks must also address the issue of slowing growth, declining margins and increased competition in their existing markets. It will be interesting to observe the company’s performance as it tackles these challenges.