STARBUCKS

Alaa Sulaiman

Intermediate Managerial Finance

Introduction

Starbucks Corporation was established in 1971 in Seattle USA, as a leading specialist in marketing and retail of coffee. Not very long after its successful launch, the corporation started expanding globally, and produced coffee at a much larger scale worldwide. The corporation currently has a massive market presence in about 62 countries, and runs round about 20000 retail and operation stores with approximately 180,000 employees. These figures provide quite a decent overview of the company’s success, while the years from its establishment reflect on the struggle behind that success (Craig J. Thompson, Zeynep Arsel, 2004). On Starbucks’ menu is a wonderful line of products ranging from premium quality roasted and handcrafted coffees and tea, to a range of fresh food items and beverages (Yue, Lorene, 2003). The Company offers variety of tea and coffee across its network of stores. It also applies – very intelligently – several marketing strategies in order to strengthen its market presence. It uses strategies involving licensing, franchising, local and national foodservice accounts as a means of promotion. The company also utilizes marketing and branding with industry relevant brands such as Teavana, Tazo, and Seattle’s Best Coffee.

Industry OverviewStarbucks basically relates and largely operates in the retail coffee and snacks store industry, an industry that faced a severe slowdown as a result of the economic crisis and the change in consumer tastes in 2009.

While several industry experts consider the gourmet coffee industry in stage of growth, signs around the country designate that this industry is in its maturity in the context of product life cycle. This maturity stage of Starbucks perceives wide distribution, high brand awareness, and lower prices to be competitive in the market and product modifications/enhancements to have an impact of brand distinctiveness (Lister, Media, 2013).

Starbucks’s Core CompetenciesOne of the major reasons for its constant and steady expansion is it’s consistent core competencies i.e. its strengths. The company possesses a very strong market positioning and global brand recognition attained through constant review of marketing strategies, and improvements in the allocation of the four Ps of its marketing mix (Helliker, Leung, 2002). As elaborated earlier, the company has a market presence in 62 countries, which directly implies its belief over market penetration. The company’s line items reflect on yet another strong point of the company, i.e. new product development. Along with these facts, Starbucks also licenses its brand logo and further uplifts its brand equity via merchandizing. This enables the company to further improve its brand recognition, eventually easing-off the endeavors of market expansion (Belson, 2001).

A part from the aforementioned facts, Starbucks stores are also very intelligently planned and designated. They are located in prime target markets of the regions, and are well researched

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before initiation. The company has very well benefitted from the booming technology, and has appointed social media marketing brilliantly. Moreover, the Starbucks App has catered to further enhancing its market appeal, as well as presence across the globe (Starbucks Corporation, 2014).

Starbucks Stock Performance: Past five yearsStock performance shows the measure of returns on shares in a given time period. It can be measured through several methods encompassing their respective properties. Usually portfolio managers on a daily, weekly or annual basis measure stock performance. The stock performance of Starbucks for the past five years can be described as follows:1. Total Returns on Stock

1 month returns

YTD returns

1 year returns

5 year returns

Starbucks 6.04% 46.90% 66.38% 367.6%

S&P 500 Total Return

3.79% -0.08% 10.05% 91.69%

Chipotle Mexican Grill

-0.48% 5.66% 11.07% 299.0%

McDonald's 6.99% 13.65% 17.93% 58.25%

Starbucks stock performance in terms of total returns on stock has been phenomenally higher for the past five years. Total returns of 367.6% in the last five years depicts the company’s positive position within the industry, while also shows that its stock performance was the highest in comparison to its key competitors.

2. Stock Price Versus Earnings

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Starbucks has experienced a considerable level of increase in its stock prices over the past five years. The price has increased from 23.05 of 2010 to 59.93 in the year 2015. The company has also experienced a parallel gain in its Earning Per Share that started at the rate of 0.833 in 2011 and prevailed at 1.78 in 2015.

3. Earning Yield Versus Dividend YieldEarning yield for Starbucks has experienced a significant variation in the past five years. Its current earning yield is 2.98%, which has dropped from 4.11% of 2011. The company’s dividend yield has shown only a negligible level of variations.

Cash Flow Analysis and Key Value Drivers for StarbucksFor Starbucks, the primary key value driver can be considered as its high profit margins. The company accomplishes high profit margins through keeping the higher-income segment of the population as its target market. Its focus is on youth and college-going adults who tend to demonstrate a greater inclination towards luxury products. The higher profit margins yielded from high prices are then utilized for the purpose of financing the key company facilities, store and retail outlets, and to maintain a signature luxury atmosphere at the coffee shop.

Another essential key value driver for Starbucks Coffee is its high sales growth. To attain higher sales growth, the company offers attractive incentives for its customers like free Wi-Fi connectivity for its store customers along with a variety of good books to read, and great music to enjoy that leisure time in an exclusive Starbucks environment. It also emphasizes a great deal on maintaining the premium quality of its products so that the customers stay loyal to the brand. All of these factors contribute to a higher sales-growth for the company, and is a key value driver.

The following projections have the assumptions shown in:Appendix A: Income statement assumptions, and Appendix B: Balance Sheet assumptions:

Projection

09/30/14 09/30/15 09/30/16 09/30/17 09/30/18

Net Income 2,134.10 2,344.31 2,532.95 2,729.08

2,911.60

Plus Interest Expense 35.00 35.00 35.00 35.00

35.00

Plus Income Tax Provision 1,051.12 1,154.66 1,247.57 1,344.17

1,434.07

EBIT 3,220.23 3,533.98 3,815.53 4,108.25

4,380.68

Minus Cash Paid for Taxes1 - - - - -

Plus Deprec & amort. 746.60 837.20 919.60 993.70

1,067.80

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Plus/minus Other non-cash items 190.00 225.00 250.00

300.00

350.00

OPERATING CASH FLOWS 4,282.43 4,703.58 5,109.23

5,526.05

4,380.68

Plus/minus

Investment in Working Capital (0.33) 41.46 36.83

34.85

31.93

Minus Capital Expenditures (1,100.00) (1,100.00)

(1,000.00)

(900.00)

(900.00)

FREE CASH FLOWS 3,182.10 3,645.03 4,146.06 4,660.90

3,512.61 71,808

Starbucks Capital StructureStarbucks comprises of a potentially strong capital structure pertaining to its recognition of delivering high-end in-store experience. The company entails strong cash flows and has a constantly improving capital structure. Starbucks’ Capital structure-specific interpretations are as follows:Beta of Equity (yahoo finance) 0.82Market Cap $88.95BRisk-Free Rate 3.0%Market Premium 5.5%Cost of Equity 9.56%Total Debt to Total Equity 38.85Total Debt to Total Assets 19.05Interest Coverage 40.20Long-Term Debt to Equity 38.85Long-Term Debt to Total Capital 27.98Long-Term Debt to Assets 0.19Cost of Debt 3.83%WACC 9.43%

The leverage ratio of the companies is as follows. The debt increases over the period, which indicates a high leverage risk.

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- Debt to Equity Ratio: The Company’s debt to equity ratio showed improvements between the years 2011 and 2012, but started deteriorating till the year 2014.

- Debt to Capital Ratio: The debt-to-capital ratio represents the percentage of capital that was financed by debts. Since this ratio was 0.28 for the year 2014, it suggests a similar pattern – like that of Debt to Equity Ratio – was observed for the company’s debt-to-capital ratio, where it improved from 2011 to 2012, but started deteriorating till 2014.

- Interest Coverage: Starbucks’ interest coverage ratio also demonstrated significant improvement in 2014, despite the deterioration on 2013.

Market Reaction to the Announcement of a New Stock SplitSome investors might be interested to see that Starbucks is splitting its shares – even though they’re south of $100. The announcement of stock splits signals that company’s assets are overvalued, which consequently result in a notable reduction of share prices. Shares of Starbucks were trading for $94.06 at the announcement, and now they are down to $59.93.

Market Reaction to the Announcement of a New Bond IssueThere exist positive cumulative average abnormal returns suggesting that new bond offers are considered to be favorable news by the market (Chin, Abdullah, 2012). However, studies suggest that the market reaction to announcements of new bonds is irrespective of a corporation’s characteristics such as profitability, growth and liquidity. Companies are assumed to maximize the wealth of bondholders, while corporate events are often considered to lead to a change in the trade practices of a company’s common stock. Moreover, the determinants of a company’s capital structure have some influence over the issuance of new bonds.

Optimal Capital StructureAccording to studies, the value of a firm with higher leverages is significantly greater than that of an unleveraged firm of a similar capacity. This value is subjected to a favorable tax treatment of interest expense. As elaborated earlier, a firm’s share prices are reduced upon announcement of new shares; its market value is also decreased. An optimal capital structure is one, which encompasses a balance of ideal debt-to-equity range and minimum cost of capital. Since Starbucks cost of capital increased for the forth year i.e. 2014 along with its debt to equity ratio’s deteriorations, Starbucks does not have an optimal capital structure in practice for the given time period.

Starbucks Dividend and Repurchase PolicyStarbucks has a pretty straight forward dividend and repurchase policy. It offers Direct Stock Purchase and Sale Program known as the (BuyDirect Plan) offering the stockholders the ability to purchase the company’s initial shares, reinvest the dividends yielded from Starbucks partially or completely to purchase additional stocks, direct deposit cash dividends, safe keep stock certificates and sell stock and pay lower fees for transactions.

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The company’s dividend and repurchase trends for the past five years are as under:

2010 2011 2012 2013 2014Dividend Paid 171.0

0M389.50M

513.00M

628.90M

783.10M

Shares Outstanding

764.20M

769.70M

773.00M

762.30M

763.10M

Dividend Paid Per Share

0.22 0.51 0.66 0.83 1.03

Price at Year End 31.81 45.85 52.64 78.55 82.05Dividend Yield 0.70% 1.10% 1.26% 1.05% 1.25%

Figures in USD. Fiscal year ends in September2010 2011 2012 2013 2014

Shares Outstanding

764.20M

769.70M

773.00M

762.30M

763.10M

Stock Bought Back

-2.39%

-0.71%

-0.43%

1.40% -0.10%

Analyzing the aforementioned data, it can be seen that Starbucks has been engaged in paying dividends since the last five years, which is a sign of the company being well established.

Keeping in view the company’s previous practices on dividends and repurchases, its policy for the next three years are expected to be similar in nature, however, stock splits might not be in their intension if the stock price stayed stable in the coming period.

Starbucks Risk Management StrategyStarbucks has a well-devised risk management plan in practice, which is known as the Crisis Management Plan in the company’s language. Its sole purpose is to communicate the major company needs and requisites to the key organizational members as well as the members of the community. Its risk management plan comprises of the following components.

LiabilitiesStarbucks puts a great deal of emphasis over immediate action to any risks or crisis that may occur. It considers the safety and well being of its partners to be of utmost significance. It uses

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efficient information dissemination strategies across its departments to ensure the safety of its partners.

ConfidentialityStarbucks strives towards the preservation of confidentiality by limiting the disclosure of information by employees during their daily routine tasks. It has specified confidentiality protocols and authorizes only certain key members to disclose and discuss any sort of information among the customers or the media.

Risk and VulnerabilitiesStarbucks undergoes excessive market research for the sake of risk management. It devises strategies in line with the risks and threats that are identified through this research. Key risks and vulnerabilities facing Starbucks include the following:

- Food Mislabeling: Starbucks ensures there is no such food mislabeling that may pose a threat to public safety or interests. This is a key concern for the company, and is mitigated through strict and immediate actions.

- Government Regulations: although government regulations are strictly adhered-to by the company, yet a balance between maintaining government regulation practices along with fulfilling customer needs is a major risk for the company. Consumer tastes and needs do not remain the same, and are subjected to change through time.

- Disgruntled Employees: honesty, integrity and devotion on the part of employees are another major concern for Starbucks, and are also reasons for its success and fame. The company makes every effort to keep its valued employees on board and ensures the provision of respect and satisfaction to employees for the purpose.

Starbucks operates on an Umbrella Risk Management Policy to manage its exposure to different risks within the consolidated financial statements. According to this policy, the company can undergo transactions involving various derivatives having maturities no longer than 5 years for the purpose of hedging interest rate risk, commodity prices, purchases, assets and liabilities. Each derivative is recorded in the balance sheet at fair value.

The comparison of Starbucks with its direct comparison is as follows:

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Source: Yahoofiannce.com

Starbucks Multinational Financial ManagementBeing a globally recognized brand, Starbucks indulges in a multinational financial management approach, ensuring effective use of resources at the right time. The company considers a set of attributes while expanding internationally, while a key emphasis is laid over financial resources to expand rapidly while preventing imitations. The company does not incur separate advertising expenses, and makes the most out of its stores and retail outlets as its key source of advertisement and promotion (Holmes, Stanley, 2002).

Firm’s Vale Analysis:The recent stock performance of Starbucks Corporation is evident of the fact that the performance of Starbucks Corporation has been significant and positively increasing. In the previous 5 years in the industry, the performance of Starbucks is significantly higher than the performance of its competitors in the industry. Despite of this significant increase in the performance of Starbucks the CEO of the company believes that there is still a room for improvement for Starbucks Corporation in order to achieve higher and potential future growth. The Starbucks Corporation needs to enhance the volume of its store traffic so that maximum amount of products offered by Starbucks Corporation could be sold for better and potential oriented future growth. The present Starbucks Corporation is stronger than the previous Starbucks Corporation some years ago due to its recent positive and significant performance, yet by increasing the traffic the performance of the Starbucks Corporation in future could be enhanced. As far as social networking and social marketing of Starbucks Corporation is concerned, the reputation of Starbucks Corporation in social media is popular than its competitors: twitter, Facebook and Snap Chat with reference to their social media popularity. However, Starbucks Corporation can still improve their social media marketing in order to

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capitalize the greater segment of market for the future higher growth for the company. These small changes in Starbucks Corporation could result in further significant success for the company in near future looking at its present performance and potential. Starbucks Corporation needs to improve its position by using such minor changes, which would increase the customer satisfaction for Starbucks Corporation (Graham, 2010).

Beta at Actual Debt/CapDiscount Rate 8.04%Perpetual Growth 3.00%

P.V. of Cash flows (Thousands) $15,163P.V. of Terminal value (Millions) $48,784Total Present Value $63,948Equity Value $62,648Value per share $82.60Current shares out. 758.42

The stock price should be $82.60 as compare to the current market price of $59.93 (October, 18, 2015). Thus, stock appears to be undervalued by (82.60 / 59.93) – 1 = 37.82%.

Valuation Results:By simply using the discounted cash flow analysis conducted on Starbucks Corporation in this report, it is suggested that the value per share in the debt portion of total capital structure for the calculation has increased if compared with the value of share calculated by using actual ratio of debt and equity in total capital structure of Starbucks Corporation. Another significant reason for the increase of value per share is because the discount rate used in the calculation for Starbucks Corporation was lower as compare to the discount rate used for the calculation of value per share in actual scenario. The projections are taken from 2014 to 2018. I used flat rate for growth (3%) beyond some horizon. Due to the selection of low discount rate (8.04%), the calculated present value of cash flows increased as compared to the actual scenario and due to the increase in present value of cash flows, the calculated value per share for Starbucks Corporation increased as compare to the actual value per share. There can be other significant factors than these due to which there is a difference between actual stock price and calculated stock price for Starbucks Corporation by using discounted cash flow analysis.

Recommendations:Starbucks Corporation is one of the leading coffee maker and coffee sellers in United States. The recent stock performance of Starbucks Corporation has shown significant increase in their performance. During the past 5 years, the stock performance of Starbucks Corporation has been significantly positive for the corporation. By looking at the stock performance of Starbucks I would be happily buying some stocks of the Corporation. Another reason for buying the stocks is

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the potential future growth of Starbucks. The decision of buying Starbucks can be justified by looking at the changes made by the corporation management in order to incorporate innovation for future success. During the last few years, the customer satisfaction level for Starbucks Corporation has significantly increased, which is also a significant factor in the decision of buying Starbucks stock. The Corporation has also regularly paid dividend for its shareholders in its history, which is another reason for buying the stock. During the year 2014, Starbucks Corporation has announced dividend in cash form for three times while during the year 2013, Starbucks Corporation issued cash dividend for four times. The recent history of Starbucks Corporation for dividend announcement and dividend payment has been positive; therefore buying Starbucks stock is a wise decision to make at this point.

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References

Belson, Ken (2001), “As Starbucks Grows, Japan Too, Is Awash,” New York Times, Business Section, October 21, BU 4–5.

Craig J. Thompson and Zeynep Arsel, (2004), The Starbucks Brandscape and Consumers’ (Anticorporate) Experiences of Glocalization, Journal of Consumer Research, Vol. 31, No. 3

Graham, K. (2010, 01 22). Why Starbucks Has Room to Improve. Retrieved 10, 16, 2014, from Minyanville: http://www.minyanville.com/businessmarkets/articles/starbucks-growth-upgrade-profit-price-hikes/1/22/2010/id/26485?refresh=1

Helliker, Kevin and Shirley Leung (2002), “Counting Beans: Despite the Jitters, Most Coffeehouses Survive Starbucks,” Wall Street Journal, September 24, A1, A11.

Holmes, Stanley (2002) “Planet Starbucks: To Keep Up the Growth, It Must Go Global Quickly,” Business Week Online, http://www.businessweek.com/magazine/content/02_36/b3798001.htm

Lister, J. Media, D. (2013) The Product Life Cycle of the Gourmet Coffee Industry. http://smallbusiness.chron.com/product-life-cycle-gourmet-coffee-industry-37334.html

Yue, Lorene (2003), “Perks Often Follow Coffee Shop: Starbucks Signals Retailing Ripeness,” Chicago Tribune online edition, October 26, http://www.chicagotribune.com/archives

Wall Street Journal, October 18. Retrieved from: http://quotes.wsj.com/SBUX/financials

VW Staff. (May 5, 2015). “Market Risk Premium & Risk-Free Rate Used For 41 Countries In 2015,” ValueWalk. http://www.valuewalk.com/2015/05/market-risk-premium-risk-free-rate-used-for-41-countries-in-2015/

Ycharts, Data. Retrieved from: https://ycharts.com/companies/SBUX/net_income_ttm

Matt Krantz (March 18, 2015), “Starbucks splits stock. Who's next?” America`s Market. Retrieved from: http://americasmarkets.usatoday.com/2015/03/18/starbucks-splits-stock-whos-next/

Adam Jones. (Dec 2, 2014). “Starbucks’ year-to-date returns”. Market Realist. Part 3. Retrieved from: http://marketrealist.com/2014/12/starbucks-year-date-returns/

Vuru. Retrieved from: http://www.vuru.co/analysis/SBUX/dividendsBuybacks

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Appendix:

Appendix A:

Income Statement 09/30/13 09/30/14 09/30/15 09/30/16 09/30/17 09/30/18

Total Revenues

14,892.00

16,687.00

18,337.00

19,803.00

21,190.00

22,461.00

Bloomberg 2014, 2015. 8% in 16. 7% in 17, 6% in 18.

Cost of Sales

6,382.00

6,674.80

7,334.80

7,921.20

8,476.00

8,984.40

40% per Bloomberg's estimate 14,15. Use same for other years.

SG&A 6,302.00

7,091.98

7,793.23

8,416.28

9,005.75

9,545.93 0.425 X Sales

EBIT 2,208.00

2,920.23

3,208.98

3,465.53

3,708.25

3,930.68

Other 375.00

300.00

325.00

350.00

400.00

450.00

Includes Equity Method Earnings

Interest 28.00

35.00

35.00

35.00

35.00

35.00 Ad hoc

Taxes 832.30

1,051.12

1,154.66

1,247.57

1,344.17

1,434.07 Use 33%

Earnings 1,722.00

2,134.10

2,344.31

2,532.95

2,729.08

2,911.60

EPS 2.27

2.81

3.09

3.34

3.60

3.84

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Appendix B:

HistoricalBalance Sheet 09/30/13 09/30/14 09/30/15 09/30/16 09/30/17 09/30/18

Cash +STI 3233.8 897.13784 1913.1834 3296.3166 5048.12225 7054.1249A/R 561.4 628.98605 691.1798 746.43799 798.718432 846.62646 Sales/26.53Inventory 1111.2 1259.3962 1383.9245 1494.566 1599.24528 1695.1698 COGS/5.3Other Current 502.5 563.06859 618.74446 668.21162 715.013094 757.90038 Sales GrowthTotal Current 5408.9 3348.5887 4607.0322 6205.5323 8161.09905 10353.822PPE, Cost 7965 9065 10165 11165 12065 12965 See belowAccum Deprec -4765 -5511.6 -6348.8 -7268.3 -8262 -9329.8 See belowNet PPE 3200 3553.4 3816.2 3896.7 3803 3635.2Equity Meth. + LTI 554.8 664.8 764.8 864.8 964.8 1064.8 AdhocGoodwill 862.9 862.9 862.9 862.9 862.9 862.9 Leave AloneOther Noncurrent 476.9 534.38291 587.22235 634.1694 678.586557 719.28894 Growth in SalesTotal Assets 10504 8964.0716 10638.155 12464.102 14470.3856 16636.01

Accounts Payable 491.7 514.23729 565.08475 610.26194 653.004622 692.17257 COGS/12.98Current Portion 0 0 0 0 0 0Taxes PayableOther Current 2103 2356.4841 2589.4917 2796.5155 2992.38316 3171.8697 Sales Growth

Total Current 2594.7 2870.7214 3154.5765 3406.7775 3645.38778 3864.0422Long Term Debt 1299.4 1299.4 1299.4 1299.4 1299.4 1299.4 Left Alone

0 0 0 0 0 0Deferred TAxes 414.4 464.3495 510.26409 551.0585 589.65458 625.02272 Sales GrowthTotal Liab 4308.5 4634.4709 4964.2406 5257.236 5534.44236 5788.465C/S 0.8 0.8 0.8 0.8 0.8 0.8 Leave AloneAPIC 282.1 282.1 282.1 282.1 282.1 282.1 Leave AloneRetained Earns 5843.5 3977.6008 5321.914 6854.8658 8583.94325 10495.546Min Int 2.1 2.1 2.1 2.1 2.1 2.1 Leave AloneAOCI 67 67 67 67 67 67 Leave AloneTotal OE 6195.5 4329.6008 5673.914 7206.8658 8935.94325 10847.546

1622 8964.0716 10638.155 12464.102 14470.3856 16636.01