What’s Behind Millennials favorite brands?
Starbucks: A Growth Story
In his book One Up on Wall Street, guru investor and bestselling author Peter Lynch advises the reader to stop listening to Wall Street “professionals” and take their investments into their own hands. The reason for this advice is that the non-experts have many advantages over the Wall Street analysts, which is a rare but valuable piece of advice coming from a guy that was a Wall Street portfolio manager himself. The advantages average millennial Joes and Janes have over the professional investors are that we know the companies, brands and products we consume in our daily lives.
Since the beginning of the 21st century, we’ve seen a raising wave of consumer activism around the world. People are increasingly more interested in knowing how the products they consume are made, where the raw materials and labor behind those products are sourced from, and the way companies interact with their communities. Increasingly, consumers around the world know the governance practices behind those companies and have an unprecedented access to the information of any company. The age of social media helps us to keep informed of everything happening in the world. We know if a company is doing well, what we and our friends shop, what they eat, what are the new trends in the world of business, etc. All the information you need to know if a company is doing well and if you could make money investing is right there in front of your eyes.
Once you know of a company that you think is going to do great or still has significant growth potential, it is time to do your homework. Some of us that are fresh out of school or college still have traumas about the nightmares caused by our teachers’ homework, but I promise this is much less boring and frustrating than your high school assignments. Doing proper research in a company before you invest your money in it is really important as is easy to lose money by falling in what our last week’s article called “cult stocks”. These are companies that although may have interesting and upcoming products, their finances don’t necessarily check out.
As an example of what I’m talking about we’ll see what one of millennial’s most beloved companies, is up to these days. Starbucks is by far the most beloved and recognized coffee store chain in the world. They are the reason we millennials (and some older people) are known for having such complicated types of coffee and care about not only the price of the coffee itself, but also about how the beans are sourced and, by adding the Fair-Trade label to their products, if the farmer that grows the coffee beans is paid a fair price. Yes, they’ve changed the way we buy our coffee. Starbucks is one the greatest growth stories of our time. The company’s stock has outperformed the markets by a factor of two consistently in the last ten years. If you would have invested $100 then, you would have had around $252 now. Not bad considering the general market has grown only 60% in the same time and the big majority of stock pickers haven’t been able to beat that. Lately, the analysts and experts have been having some concerns about the company’s future now that long-time CEO (the boss) Howard Schultz announced that he’ll be stepping down in April of this year. This has caused the stock of the company to go down 2% so far, this year. So, the question remains, has Starbucks still legs to grow and beat the market?
To answer this question, we have to first read the income statement to see how much Starbucks’ sales have grown in recent years, how much of those sales have translated into earnings, and see how much of those earnings have translated into operating cash flows (earnings after adding non-cash expenses like depreciation back and subtracting all those cash expenses that don’t show in the income statement), and see how this will change in the future.
Starbucks’ sales have grown at an average rate of 13% in the last three years (10.6% in 2014, 16.5% in 2015 and 11.2% in 2016) and an increase of 6.7% in year-to-year sales last quarter. Analysts are concerned with the growth of sales of retail coffee in the future as market experts forecast growth rates to slow down. To counter these forecasts Starbucks is expanding towards more premium stores with the announcement of 25 to 30 new “Roastery” and “Reserve” stores including the highly-publicized Milan store that is planned to open in 2018. Also, the company plans to expand their “Channel Development” portfolio (all those Starbucks products you can buy at the supermarket), as this sector is expected to enjoy larger growth rates and Starbucks has the most powerful brand in world of coffee. In addition, Starbucks is looking to diversify its business to related products like high end experience store chain Teavana, Princi and juice brand Evolution Fresh.
Another way Starbucks is trying to keep sales growing is by expanding their mobile app purchases, which represented 7% of all transactions last year. A significant proportion considering that it represented only 3% of all transactions just a year before. The volume of mobile transactions has increased so much, that in 1,200 stores they account for 20% of all transactions at peak time which puts a lot of pressure on baristas that see how demand exceeds capacity (which being honest is a good problem to have). This modality of selling is important to consider as it also gives the company the option to open express stores in places with high traffic and people are in a rush. All these considered, we are confident that Starbucks can maintain sales growth rates of at least 10% in the next five years.
The second important set of metrics we are going to use to find the value of the company, are the operating income earnings. Earnings or net income refers to all the accounting profits generated by the company in a particular period. This differs from the company’s cash profits as we’re going to see later. The operating income, or earnings before interests and taxes of the company, has remained fairly constant as a percentage of sales in the last two years. It ranges from 16% to 19% which represents stable behavior in the company’s operations. We expect Starbucks operating margins to rise to 23%-25% as a proportion of sales in the next five years as they are expanding their business into more profitable segments. As I mentioned before, Starbucks is expanding in their “Channel Development” division (remember all those Starbucks products you can buy in the supermarket) which in many cases is just a way of licensing Starbucks’ brand to put in other products. Like their possible partnership with Nespresso to make Starbucks branded coffee pods and for their espresso machines. Another way margins are going to be improved is by moving to more premium segments (also as mentioned before) which gives the company the opportunity to also raise prices.
Finally, we have to see how the accounting profits translate into cash profits to assess how much the company’s stock is really worth. As a first step, to convert earnings into operating cash flows. Then, we deduct the capital expenditures which is what the company spent in plant property and equipment for the period. The result of this is the free cash flow. The end step would be to divide all the future free cash flows to bring them to present value and add up all the results to perpetuity. The sum of all those cash flows is the total value investors are willing to pay for the company’s equity. In the case of Starbucks, our total valuation is $94.2 billion. Divide that number for the amount of stocks outstanding in the market at the moment and so you get your target price. The target price we believe the company is worth is $64.65 per share. As you may have noticed by now, that is not the company’s stock price in the market at the moment (03/10/2017). As matter of fact, Starbucks’ stock price at the time this article was written was $54.53 per share. That means that we believe the company’s stock price is going to increase more than $10 (or 18.62%) in the next twelve months as the market adjusts the price to its “fair value”. So go ahead and start investing your own money in the things that you know and love.
If you liked our article, please like and share, help us get millennials to make wise investments and get interested in the stock market. See you next week!
Disclaimer: This article is based purely in our own knowledge, experience, and research. It should not be taken as an expert’s advice for stock picking.
Helpful Links:
Operating Cash Flow: http://www.investopedia.com/terms/o/operatingcashflow.asp
Capital Expenditures (CapEx): http://www.investopedia.com/terms/c/capitalexpenditure.asp
Discounted Free Cash Flows (DCF): http://www.investopedia.com/terms/d/dcf.asp
