Monday, January 27, 2014

Starbucks Pushes Further Into Grocery With Seattle’s Best- 01/17/2014


  1. Financial overview
    Revenue (3.8B in Q4 13), operating income (858M)
    Geography: Americas 73%/71%, , EMEA 8%/3%, CAP 7%/11%, Channel development 9%/15%.

    Operating margins ratio:17.6% in Q4 13 up from 15.4% same quarter in 2012, higher than the industry average- 15%

    Q4 13, "by far the best year" quoted form the CEO,
    Total net revenues increased 13%, OI increased 29%, EPS increased 37%.

    FCF conversion ratio problem: FCF (FCF to the firm is also a common figure in valuation, which is simply FCF- interest expense*(1- EFFECTIVE tax rate)). According to the Corporate finance textbooks, FCFF should be used in finding enterprise value.
    It seemed that Free cash flow is a confusing topic for us, so I got some additional data from Bloomberg.
    FCF= Cash flow from operatings- CapEx or EBIT(1-Tax Rate) + Depreciation & Amortization - Change in Net Working Capital - Capital Expenditure

    From Bloomberg: FCF 2011, 1083M (9.3%); 2012, 894M (6.7% of Rev) ; 2013, 1757M (12% of Rev).
    - Americas market growth is in line with the industry
    - (New segment, K Cup, in retail places, appeals to customer preference)
    - Great growth potential in Channel development segment, it was founded 2 years ago and now contributes 15% of the operating income
    - CAP's margin ratio is improving

    - Commodity risks, Arabica coffee beans production is affected by weather, thus very unpredictable also premium paid to acquire high quality beans depends on supply and demand at trade
    - Competition risks, specialty coffee market is intensely competitive

    Relative valuation
    SBUX OM 17%, P/S 3.81, PEG 1.46
    Tim Hortons OM 17%, P/S 2.74, PEG 1.7
    Green Mountain OM 20%, P/S 2.51, PEG 1.4

  2. Starbucks has four reportable operating segments: Americas, Europe, Middle East, and Africa ("EMEA"), China and Asia Pacific ("CAP") and Channel Development. Seattle’s Best Coffee is reported in “Other,” along with Evolution Fresh, Digital Ventures etc.

    1, Business categories
    company-operated stores 79.20%
    Licensed stores 9.10%
    CPG, foodservice and other 11.70%

    2, Reporting segments Revenue Operating profit
    United States 73.87% 74.7%
    Channel Development 9.54% NA
    EMEA 7.8% 2.03%
    China/Asia Pacific 6.16% 10.14%
    Others (Global Consumer Products Group)

    FCF conversion ratio-

    1, the company’s strategy is to balance near- and long- term sales and margin-driving initiatives across its unique cross-platform strategy of Starbucks stores into CPG channels.

    2, a more focused individual international market strategy, with specific attributes to drive China in a different way from Canada, and from the UK or India.

    3, long-term momentum in Americas looks sustainable given robust pipeline of sales initiatives and margin opportunities.

    4, Coffee costs have been a primary headwind, with $400m of pressure on a consolidated basis across the company over the last two years now turning into a tailwind. In particular this will impact channel development as the segment has the highest COGS exposure to green coffee.

  3. CAGR of revenue from 2009 to 2012: 8%
    CAGR of operating income: 37%
    5 Segments:
    -Americas: 75%, 103%
    -Europe, Middle East/Africa: 8.6%, 1%
    -China/Asia Pacific: 5.4%, 12.7%
    -Channel Development (packaged coffee and tea): 9.7%, 17.4%
    -Other: 1.6%, 35% of loss

    Revenue by products:
    Beverage: 59%
    Food: 16%
    Packaged and single serve coffees: 15%
    Other: 10%

    Company-operated stores: America: 61%, EMEA: 47%, CAP: 20%
    Generate 80% of total revenues

    Operating margin:
    Starbucks: 15%
    Green Mountain: 17.6%
    McDonald’s: 30%
    Dunkin Brands: 39%

    Free cash flow/revenues:
    Starbucks: 13%
    Green Mountain: 2%
    McDonald’s: 18.6%
    Dunkin Brands: 25%

    Dividend yield: 1.3%, same with the industry
    ROE: Starbucks: 0.18%; Industry average: 27.5%
    PE: 33.4, industry avg: 28.7

    -Tea shops, will open nearly 1000 new shops in next 2 years
    -Open more franchise store in emerging markets

    -Lawsuit against Kraft, Starbucks has to pay $2.57B. last quarter the high operating cost
    -Public relation in China

  4. Operations-wide, Starbucks is roughly 80% of company-operated stores, and 20% specialty operations. Starbucks company-operated stores sell high-quality beverages, food, packaged and single serve coffees, coffee-making equipment and other merchandise. The stores provide a unique consumer experience with great customer service. The specialty operations include licensed stores, which is 9% of the total revenue, Consumer Packaged Goods 7%, and Foodservice 4%.
    In terms of Geography, Starbucks is 74% in Americas, 9% in Channel Development, which sells worldwide whole bean and ground coffees, premium Tazo teas and so on through channels such as grocery stores, 8% in Europe, Middle East, and Africa, 6% in China / Asia Pacific, and 3% all other segments. Operating income within and outside of the U.S. is proportional to the revenue within and outside of the U.S.
    Free cash flow as a percentage of revenue had been decreasing from 2010 to 2012, but almost doubled in the 2013 fiscal year. It was 12% in 2010, 9% in 2011, 7% in 2012, and 12% in 2013. This reflects the company’s strong fundamentals and indicates its potential ability to expand the company-operated stores internationally.
    There are analysts who think the U.S. consumers are becoming more cautious in spending money on restaurants. But Starbucks will be less affected for two reasons, I think: 1) Starbucks has a strong brand loyalty through its signature in-store Starbucks Experience, the Starbucks card, and My Starbucks Rewards program; 2) its customers are generally wealthier, more affluent, and are less affected by the slowing industry trend.
    Starbucks is probably in the early stage of store expansions in some international markets, such as China, India, and Russia. In Financial Year 2013, the number of stores in China has increased by over 50%. Moreover, Starbucks is expanding into new products, such as baked goods, tea, orange juice, and Starbucks-branded K-Cups. In addition, I agree with Bill’s findings that coffee prices are falling, and are projected to keep the trend into 2014. Starbucks will likely to benefit from such falling commodity prices.
    In conclusion, with the fore-mentioned opportunities, I would recommend to buy Starbucks stocks with the current relatively low P/E ratio.