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No. of Recommendations: 25
School starts on Monday so I thought I would try to analyze one more stock. I chose to do SBUX because I saw on the best buy list and that David and TMF owns shares in this company. I'm still trying to understand the best things to do when analyzing a company so bear with me if it isn't that great, but I'll try. Here's my analysis-

Business

Here is Yahoo's description of the tribe-

Starbucks Corporation engages in the purchase, roasting, and sale of whole bean coffees worldwide. It offers brewed coffees, Italian-style espresso beverages, cold blended beverages, various complementary food items, coffee-related accessories and equipment, a selection of premium teas, and a line of compact discs, through its retail stores. The company also sells and licenses its trademark through other channels. In addition, Starbucks Corporation produces and sells ready-to-drink beverages, which include bottled beverages and espresso drinks, and a line of ice creams. Its brand portfolio includes superpremium Tazo teas, Starbucks Hear Music compact discs, Seattle's Best Coffee, and Torrefazione Italia coffee. As of September 30, 2007, the company operated 8,505 retail stores. Starbucks Corporation was founded in 1985 and is based in Seattle, Washington.

Well, that long description pretty much wraps up the company. To make it simple, their stores sell mostly coffee and some other types of basic food. Their customers could be anybody that wants coffee. It could be teachers wanting coffee to start their day at school (half my teachers do it), people that want it before going to work, teens that want to just be cool by drinking SBUX coffee, or even your dog might like it (I do hope you didn’t give it any. ;-)). Now that many SBUX stores are starting to have drive through windows, it makes it more convenient for people to get their daily coffee. People know SBUX for coffee more than any other business in the nation. This gives them somewhat of a moat with people knowing them above all else. I just thought of this, but caffeine is proven to be addictive and this would make people buy their products over and over again. This repeat purchasing adds more strength to the economic moat. This moat can last as long as people don’t switch over to a competitor.

SBUX’s main competition that I see is MCD. There is also many other small coffee companies that might be some competition, but that’s nothing compared to this fast food giant. To many people, SBUX has the better tasting products and it is worth paying the extra money. To many others though, saving money is more important and spending it on coffee is not necessary. When you can get your same coffee for more than half price, which company would you buy your coffee from? That only sounds like common sense, but when you add in the fact that SBUX’s coffee is considered higher quality and it is cooler to get, many clueless people will go to SBUX. Some people just can’t stand MCD’s food and I understand that, but seriously, a deals a deal and that’s most likely the way to go. One other competitor I see to SBUX are the companies that sell instant coffee such as Folgers. Right now they are owned by Procter and Gamble, but they will soon be bought out by Smuckers and all PG shareholders will end up with a small part of Smucker’s business.

All the competition between these companies has their own advantages and disadvantages. SBUX’s advantages are they remain the most well known coffee selling business, they provide supposed higher quality drinks, and they are starting to make their business more convenient with drive through windows. Their disadvantages mostly lie with MCD. MCD provides cheaper coffee and is also fast to get it from when in a hurry. I see that MCD is their number one competition risk. What SBUX needs to do to stay ahead is keep the nice restaurant environment, which is what got them ahead in the first place. They need to keep prices stable and figure out a way to fight inflation in needed commodities. I’m not positive on this one, but I haven’t seen much advertising for them recently so that could be a thing they need to do. These are just a few options I see but there are probably many more out there. We just need to keep our eyes and ears open (and taste buds) for any news.

Financials

Let’s hit the balance sheet first. Okay, I’ll try my best to understand why things are what they are. Here goes nothing! So their cash has been a tad crazy in the past three years. It rose, then shrunk, and then rose again. Right now cash is resting at $297 million based on their latest quarterly report. SBUX has very high PP&E resting at about $3 billion. This makes up more than 50% of the assets. SBUX has very high long term debt at about $550 million based on their last quarterly report. They divided it up into what was making it this high. It turned out to be deferred rent. This long term debt should start clearing up as SBUX gets moving again. This will increase the shareholder’s equity to about $3 billion from where it is at today at about $2.5 billion. As SBUX starts getting back to their strong selves again their balance sheet should start to clean itself up in the few years coming up.

Now it’s time for the income statement. Revenue and net income have both grown over 20% annually in the past few years. This year, SBUX will be opening less stores and same store sales shouldn’t spike way up. This would keep growth rates a tad lower this year, but I’m not expecting any declines. SBUX still has the power to continue to grow even in hard times. They have already proved this. SBUX in my eyes has pretty high cost and expenses, but I don’t have a problem with it because it should help produce growth and keep the company moving. Cost of revenue takes about 40% of revenue, which leads the other 60% to make up the gross profit. Selling General and Administrative expense takes up a big chunk out of their profit, which leaves only some for the operating income. Last quarter it was actually an operating loss, down a little over $20 million. That’s not good. That could hurt their operating margin, which now is at a pretty low 7.66%.

Now let’s tackle the cash flow part of the company. This is the section that I know the least about, but I’ll try anyways. The operating cash flow has grown nicely over the past few years. This would greatly help the free cash flow, but SBUX is spending a lot on capital expenditures. I can’t seem to find what they are spending it on so if somebody could point it out that would be great. Financing cash flow is also shrinking, which is good. SBUX doesn’t pay any dividends so that doesn’t affect the company at all. That’s all I can really do on cash flow, so if you need to add anything in go ahead.

Management

This is one of the hardest things for me to grasp and understand well. All that us individual investors can do is listen to the recent reports and try to understand the management. We can’t just go talk to them about their own company. I will do my best to use my resources and try to understand SBUX’s management. I believe right now SBUX has a strong CEO. Schultz started the company and is still running it right now. One thing I don’t like is that he is CEO, chairman, and president. It might not be that bad, but I’m thinking that that gives him too much power. I think they need to get another person to be chairman or president and he can stay CEO. I think having all three of the highest positions is just being too powerful. He is also the largest shareholder with 17,739,597 shares worth $2.845 billion. That’s a bunch at stake! The only other top executive that is one of the top five shareholders is Arther Rubinfeld, the president of global development. Recently there hasn’t been much trading action in the insiders, but there have been a few buys, which is a good sign. The CEO is determined to keep the stock moving and to get out of the mess they are in. One of the great things about him is that he has a long term outlook. He doesn’t want to change things that are only in affect tomorrow. He’s looking towards the years ahead.

I have one question. I know there is a report in the SEC Filings that tells what the management’s salaries are. Management’s salaries are important because you do not want them to be overpaid. You want them to have reasonable salaries so they work more for the love of the company than for the money. If any body knows what report this is from, I would gladly appreciate if you shared it with me.

Based on what I can tell, management is determined to help the company and is trying their best to keep the company moving towards greatness. They believe in their own company by owning their own shares and a few insiders have bought shares recently. I can’t perfectly tell, but management seems open to telling investors what is going on with the company. I think the management passes the test.

Catalyst

Finding a company’s catalyst is one of the most important things a company needs. The catalyst is what keeps the company moving and without one the company is most likely going nowhere. For SBUX I do see a couple smaller catalyst, but not a huge one. These include getting out of the mess they are in. When SBUX closes 600 stores they will start cleaner and be able to grow easier when they have less stopping them. This is a one time internal catalyst and should give the company a good head start for moving up higher and higher. One more catalyst I see is when SBUX acquires other companies. These acquisitions can be smaller catalyst but if they do enough it could greatly affect the company. These are all one time catalyst but if you do it enough it could be considered an ongoing catalyst. No one can tell right now what will happen, but I think acquiring other companies will gain them more market share and should help them greatly for the years ahead against competition. These catalyst will start the company off and when more opportunities rise those will be considered catalyst and should keep SBUX moving up.

Balance

When I look at companies to invest in, this is one of my top things I want in it. I want balance between the quantitative and qualitative values of a company. You cannot have the numbers looking good and things numbers can’t cover looking bad or vice versa. When coming out of bad economic times and when company is having trouble, this can be hard to judge, but I think we are okay with SBUX. On the quantitative side of things SBUX has great growth rates, should be improving their balance sheet, has strong ROE at 19.39%, and operating cash flow has been increasing greatly just to name a few good things. They do have weak free cash flow, large debt, and commodity cost are affecting them to name just a few negative affects. On the qualitative side some pluses include determined management with a long term outlook, a strong base of customers that like the company’s products, and the increasing of people knowing about them internationally. One the down side, MCD is growing competition and should take some market share away domestically. What SBUX needs to fight this is advertise more and grow more internationally. There are ups and downs for each side for balance. Overall, I do think they are balanced enough to pass this section.

Valuation

This is the newest part to me than any other so I’m only going to do a couple of valuations. I’m going to do the basic P/E* expected EPS in five years. I’m also going to do the DCF calculation using net income instead of free cash flow because FCF won’t be accurate at all in this company's case. Before I do that I want to run through a couple numbers right now. Right now the P/E ratio is at about 21. The industry that they are in P/E ratio is 31 and the sector’s is at 18. SBUX has had a higher P/E ratio and this is low for it right now. In the past year they have been up in the 30’s and down to the mid teens for the P/E ratio. This shows that the company is trading cheaper today. The PEG is at 1.23 which is pretty low considering that SBUX is a growth stock and that the industry’s PEG is almost double that. Once again this shows that they are trading cheaper. For a couple more ratios, the P/S ratio is at 1.11 and the P/B ratio is at 4.64.

Now for the basic expected P/E ratio * expected EPS valuation method. Analyst think that earnings can grow about 17% annually for the next five years. I think that the P/E ratio will range from 20 to 30 to be conservative. That’s pretty wide range but I’ll see what I can come up with. I’ll also do earnings growth at 15% and 20%, one above and one below analysts earning estimates. Here it is-

15% at 20- $25.40
15% at 30- $38.10
20% at 20- $31.40
20% at 30- $47.10

That looks really good. Remember, this is pretty conservative. If they can really do good, their P/E ratio could get even higher. No one can tell though. The worst at $25.40 is still 59% above the current price. The highest at $47.10 is 194% above the current price. As I said, it is a pretty big range, but no matter what way the company does, you still would make it pretty good. This valuation method makes SBUX look really good.

Now for the DCF method. As I mentioned, I am going to use net income instead of FCF. I am going to use two different discount rates. I’ll do one at 11 and one at 15. I hope this works. I’m going to add in a three percent terminal value. My computer acts up on the calculator the TMFGebinr gave me so I only got the 11 and only part done of the 15. It was around where I marked it though. Here’s what I got-

11- $29.00
15- $22.00

This doesn’t look as good as the other method, but it still shows that SBUX is undervalued. Now that these two valuation models say that it is, it is hard not to agree. If you average all six of the outcomes together you get $32.27 as the average price, which is still about 100% from the price today. Not shabby at all.

Main Risk

Now that I have completed most of my research, it is time to figure out SBUX’s main risks. Remember, Total Investment Risk= Basic Business Risk+ General Market Risk. For the business risk, I see the main risk being can they keep their powerful brand name and keep customers hooked? Another would be if they can expand internationally without running into any problems. I don’t see this happening, but other countries can be different stories, so we just need to trust management on this call. The largest risk I see is in MCD. Now that they are offering coffee, it will affect SBUX. For them to overcome this, they need to advertise to pull in more customers.

For general market risk, I see a couple. The first is with commodity prices. If the prices of needed commodities continue to rise, SBUX could have some problems with not raising prices more than they are now. This could also make profits less, which could decrease their margins and we do not want this to happen. Another problem I see is abroad. The question is if many countries will accept SBUX. They most likely have their own customs and growing there could be difficult. I went to Europe this summer and I had mixed experiences of SBUX. It could be totally wrong, but this was my experience. In Prague, people loved SBUX and the place, but in Vienna it was opposite; people went to other coffee stores that were right across the street. SBUX didn’t have anybody in the store compared to the other place.

With business and market risk added together I would probably put a medium to a medium high risk marking on this company. I see the probability of this company doing well instead of going down. With the recent price being down, I think we have a strong margin of safety with this company and that makes our chances of doing well easier.

Conclusion

I think that SBUX is a great company and should do well in the years ahead. They have strong growth rates and expanding internationally should help keep these rates up for a few years. The rough times they are going through have brought the price down and left possible shareholders with more potential value in the future. Management has a long-term outlook for the company and is determined to making the company succeed. They own their own shares, which shows they believe in SBUX. With the current price down and the company valued high compared to the price today, I believe people will be good to have shares of this company. I see great potential in SBUX.

That pretty much wraps up my analysis on SBUX. I learned a lot doing it too. Any thoughts or feedback?

Aaron
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