Starbucks Applied Financial Analysis and Security Research

This research report was originally written for a Managerial Finance course I took for my MBA.

Business Overview

Founded in Seattle, Washington in 1971, Starbucks is the largest coffeehouse chain in the world with over 30,000 company-operated and licensed locations across the world in 78 markets. In the US alone there are 8,575 company-operated locations, which makes up 49.8% of all Starbucks locations (China comes in second with 16.76% of all Starbucks locations. Starbucks trades on the NASDAQ under the symbol SBUX.

Revenue Streams

There are three main revenue sources for Starbucks:1 company-operated restaurants, consumer packaged goods, and licensed stores.

Company-operated restaurants—This makes up 80% of total revenue and is entirely owned by Starbucks (therefore, Starbucks keeps all revenue from these stores). The revenue comes from building the Starbucks Experience, a combination of food offerings, digital accommodations, and great customer service. The company’s primary goal is to continue expanding globally to maintain and increase market share.

Consumer packaged goods (CPG), foodservice, etc.—This includes ready-to-serve tea and coffee products, beverages at retail, grocery, and warehouse club stores, and sale of coffee products to foodservice companies. This makes up 11% of total revenues. Just last year on August 26, 2018, Starbucks finalized a licensing and distribution deal with Nestle to sell and market Starbucks’ CPG and foodservice products. As part of the agreement, Starbucks received a $7 billion upfront prepaid royalty payment.

Licensed stores—These are Starbucks’ franchise locations. This makes up 10% of total revenues. Starbucks earns a part of the revenue from these stores through royalties and license fees. Though Starbucks does provide licenses, these “licensed stores generally have a lower gross margin and a higher operating margin than company-operated stores” and therefore are usually licensed to “prominent retailers with in-depth market knowledge and access”. This model is different compared to their competitors McDonald’s and Dunkin’ Donuts, both corporations that have a robust franchise business model.

Supply Chain

Starbucks has a vertically integrated supply chain, thereby controlling every step of the operations from sourcing the coffee beans to producing coffee in-shop for consumers. This allows the company to keep costs low and to enforce its Coffee Sourcing Guidelines (CSG) and Coffee and Farmer Equity (CAFE) standards, which ensures there are humane working conditions and that the coffee is high quality and grown ethically and sustainably.

Industry Analysis

Competition

McDonald’s and Dunkin’ Donuts are Starbucks’ main competitors within the coffee and food industry. Starbucks, a premium brand roaster that provides a unique coffee experience, has the majority of their restaurants company-operated. Their competitors, McDonald’s and Dunkin’ Donuts follows the opposite model with few company-operated restaurants and majority licensed. For example, Dunkin’ Donuts only does franchising and relies on a third-party intermediary to handle its supply chain operations. This allows Dunkin’ Donuts to operate more financially lean than Starbucks (Dunkin’ Donuts has 50% operating margin, while Starbucks has a 19.6% operating margin).

Additionally, with one of Starbucks main initiatives to expand rapidly within China, it faces fierce competition from Luckin Coffee, China’s largest China-based coffee brand. Starbucks is currently the largest coffee chain in China with 3,683 locations. Luckin Coffee is second with 2,380 locations. However, Starbucks is expanding at a rate of one store in China opened every 15 hours, whereas Luckin Coffee is quadrupling that at one store every 4 hours.

Economic Downturn

Whereas Starbucks is a more premium brand targeting higher-income consumers, McDonald’s and Dunkin’ Donuts target blue-collar consumers who are looking for cheap coffee on-the-go. In the event of an economic downturn, there is a possibility that consumers may transform their spending habits and shift their purchases to Starbucks’ competitors, who offer the same cup of coffee for $1 less.

Additionally, Starbucks must stay vigilantly aware of the ongoing trade war between China and the United States can increase nationalism amongst the Chinese consumers, which may stimulate consumers to stray away from American brands and begin buying more from their own local brands, such as Luckin Coffee.

Upsides

Starbucks has been aggressively expanding in China, its second-largest market. By 2022, the company plans to double its number of shops in China to around 6,000 stores. Starbucks is also expanding its delivery service. Recently, the company partnered with UberEats to expand into the delivery service across the US in 11 markets. In China, Starbucks partnered with Alibaba for the Starbucks Delivers program, covering 2,100 restaurants in 35 cities.

Accounting and Financial Analysis

Income Statement

Starbucks has three main streams of revenue: company-owned store revenues, licensed store revenues, and CPG, foodservice, etc. The revenue from the three main streams as well as from the remaining streams, such as its store value cards and its loyalty program, are “recognized net of any discounts, returns, allowances and sales incentives, including coupon redemptions and rebates”. Within the past four years, the net earnings have grown at a consistent 2% with the exception of a 57% growth between the 2017 and 2018 fiscal year. This growth can be attributed to the company’s three main initiatives: increasing digital engagement, growing relevance in China and celebrating the Starbucks Reserve brand as the company’s innovation lab for the future.

These initiatives have produced major alliances between Starbucks and other major industry peers: Alibaba and Nestlé. To efficiently expedite their growth and relevance in China, Starbucks announced its partnership with Alibaba, a Chinese multinational conglomerate holding company specializing in e-commerce, retail, Internet, and technology, to provide on-demand delivery services, install fulfillment and delivery services within supermarkets, and develop a virtual store experience that would be seamless throughout all of Alibaba’s commerce platforms. To increase its global customer reach, Starbucks announced its deal with Nestlé to form a Global Coffee Alliance to license the Starbucks Consumer Packaged Goods. The deal resulted in Starbucks receiving an upfront $7.5 Billion payment from Nestlé.

With these major initiatives ongoing, Starbucks’ gross profit margins remained consistent and stable, indicating a business model that has not deteriorated or been negatively impacted by the changes.

Of their three main streams revenue generation, one of the main sources of variability throughout the years is the supply and price of the coffee beans. Multiple factors could negatively impact the supply and price within the production countries like “weather, natural disasters, crop disease, and economic/political conditions”, and within the “arabica coffee futures market, including hedge funds and commodity index funds”. These variabilities are noted within the financial statements as a risk Starbucks is aware of and vigilantly tracking.

Balance Sheet

The Balance Sheet overall has increased from 2017 to 2018 by 68.15%. Investigating further, the specific line items that saw the most changes were cash and cash equivalents, other intangible assets, goodwill, deferred revenue, and retained earnings.

Cash and cash equivalents have increased by 256.61% from $2.5B in 2017 to $8.8B in 2018. The changes are from a combination of operating, investing, and financing activities.

Other intangible assets have increased 136.11% from $441M in 2017 to $1B in 2018. Goodwill has increased 130.09% from $1.5B in 2017 to $3.5B in 2018. Both other intangible assets and Goodwill have increased because Starbucks has acquired a 50% interest in an East China Joint Venture.

Deferred revenue increased 153,893.18% from $4.4M in 2017 to $6.8B in 2018. This is from a collection of cash from customers purchasing gift cards in large volumes.

Retained earnings decreased by 73.8% from $5.6B in 2017 to $1.5B in 2018. The reduced changes are from cash dividends and the repurchase of common stock (131 million shares).

Liquidity—We can see an upward trend in liquidity from 2015 to the most recent year — an increase of 101.8% from 2015 to 2018.

Working Capital—Net working capital in 2015 to 2016 saw a drop of 34.62%. Then from 2016 to 2018, net working capital saw an upward trend with an increase of 3,125%.

Cash Flow Statement

Cash from operating activities was $11.9B for fiscal 2018, growing from the $4.3B for fiscal 2017. The increase was due to receipt of upfront payment from Nestlé in the 4th quarter of fiscal 2018.

Cash from investing activities totaled $2.4B for fiscal 2018, comparing to $0.9B for fiscal 2017. The change was mainly due to cash used to acquire a 50% ownership interest in the East China joint venture in the 1st quarter of fiscal 2018, and added property, plant and equipment driven by new store openings and increased store renovations.

Cash from financing activities for fiscal 2018 was $3.2B, slight change from the $3.1B for fiscal 2017. The small difference was due to an increase in cash returned to shareholders through share repurchases and dividend payments.

Overall, the net change in cash has a positive trend with significant increase from 2017 to 2018, mainly from the operating activities.

The EPS has been consistent around $1.90, but showed a big increase up to $3.24 in fiscal 2018. The higher EPS is a sign that Starbucks is capable of generating good dividend for investors, or that it can re-invest the funds back for more growth, indicating a worthwhile investment for shareholders.

Financial Ratios

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