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SofJay (< 20)

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Cup of Starbucks, Room for Cream Please



November 06, 2016 – Comments (0) | RELATED TICKERS: SBUX , MCD , YUM

Why is Starbucks on a year and a half long slide despite outperforming all of its industry peers?

My guess is that investors just can’t reconcile a 29 P/E multiple with the fact that this company will eventually do what its parents did and settle down.  Looking at others in the industry like McDonalds and YUM! we see that at some point meaningful growth opportunities subside and thus, the priorities of management change as well. 

The investment thesis for Starbucks should be one of value proposition.  At this price it just doesn’t make sense.  The real value for investors at this stage of the company’s lifecycle is simple.  The company has a strong brand, excellent product and as a result enjoys a loyal customer base and pricing power.  With pricing power they command high margins leaving a lot of excess cash for distributions to shareholders.  Watch as the dividend grows and the multiple comes down; when you see the inflection point buy this stock and hold it forever.

I used a FCFF valuation model to try to understand why the market seems to undervalue the operating performance of Starbucks.  Without getting too far into the weeds, I used a WACC calculation of 10.4% and assumed mid double digit revenue growth through 2020 and low double digit growth there after which is in line with the company’s 10 year average growth rate to this point.  For the terminal year I first applied the company’s current EV/EBITDA multiple of 16.64 and the results were as expected, a suggested share price of roughly $67.  Interestingly, when applying McDonald’s current EV/EBITDA multiple of 12.8 the suggested share price is $53 which offers some insight into just how the market currently values the company.

McDonalds trades at a P/E multiple of 21 versus Starbucks multiple of 29 and boasts a dividend yield of 3.35 versus 1.51.  Now the growth profile for Starbucks is far more robust than that of McDonalds and should command a premium but the disparity in my opinion is far too wide given the markets sentiment, I would watch for it to come down. 

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