Starbucks delivered record second-quarter results April 25. With every part of its business doing well (Europe excepted), its stock isn't as expensive as some would like you to believe. Investopedia's Stephen Simpson finds its current price hard to swallow given future growth likely won't be as robust as in the past. I, on the other hand, see a business performing at a reasonably high level of execution and not about to let down its guard.
Should you buy its stock? I think so. Here's why.
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Forget about earnings for a minute and consider this: the dollars loaded on Starbucks Cards in the quarter increased by 32% year-over-year. Whether through new activations or reloads (I use a card daily), it's building a huge database of information about its customers by simply making the card worth using. I could easily just put out my Visa to pay (I get travel points) but the rewards, especially the free refill, makes its card a sensible way for me to get my daily caffeine fix. Furthermore, I have one of those small cards attached to my keys (I don't believe they offer them anymore) so I never leave home without it. Its reward program is brilliant.
So, when I read a stat like the one above it isn't surprising to find out it increased revenues in Q2 by 11% to $3.6 billion. More importantly, however, is that global comparable store sales increased by 6% year-over-year and operating profits gained 26% to $544.1 million. Even better, operating margins increased 180 basis points to 15.3%. Now consider that two of its peers--Dunkin Brands (Nasdaq:DNKN) and Tim Hortons (NYSE:THI)--both have higher operating margins at 39.2% and 19.2% respectively. It's only natural to consider both more profitable.
However, that doesn't take into account their entire financial picture. Although Dunkin Brands' operating income in its latest quarter grew 12.2%, its level of debt renders its growth meaningless at almost six times EBITDA. With annual free cash flow of $132 million, it will take Dunkin more than a decade to repay its obligations. As for Tim Horton, its operating income in the past year grew by just 6.5%, slower than either Dunkin or Starbucks. Dunkin has a debt problem and Tim Horton has a problem growing profits. Starbucks has neither.
SEE: Understanding The Income Statement
The company's been on an acquisition binge the past two years dolling out $750 million for Evolution Juice, La Boulange Bakery and Teavana. With every acquisition Starbucks becomes even more vertically integrated. Evolution gives it an entree into the world of juice; not everyone drinks coffee or tea. Opening stores under the Evolution brand as well as making its products available in Starbucks locations, the company generates a higher margin than if it used a third-party supplier.
As for La Boulange Bakery, this gives the company a realistic chance of growing its food revenue. I mentioned its My Rewards (Starbucks Card) loyalty program; by assembling a database of its customer's purchasing habits, it knows exactly what type of offer to make in order to generate additional revenue. For example, I drink nothing but plain coffee. Its data tells them as much. So, I'm routinely offered a dollar or two off food purchases (one-week expiration) with my card. Once in a blue moon I'll bite and get a muffin but I've never been a huge fan of its food. By the end of 2014, it expects to have the bakery's products in all its U.S. company operated stores by the end of 2014. A higher quality (along with a fair but not inexpensive price) of food would probably persuade me to spend more. And it knows this hence the acquisition.
Its purchase of Teavana wasn't as much about wanting to own the tea market, but rather about using its operational skill to capture more of the consumer's discretionary spending. Just as there are plenty of coffee drinkers, there are also lots of tea drinkers, many of whom don't enjoy Tazo, Starbucks' own brand of tea. In the hands of someone else, discretionary dollars are going elsewhere. By bringing the country's largest tea retailer in-house, it's ensuring those dollars stay with them. It's a brilliant way to reduce your competition while ensuring your future growth.
SEE: Analyzing An Acquisition Announcement
Too Much To Mention
Teavana, Evolution and La Boulange Bakery are but three exciting additions to Starbucks. There is so much going on in its business that it's easy to lose sight of the fact that it's not a start-up but rather a business that's 42 years old. Howard Schultz commented in its second quarter conference call that many of the stores it's opened in recent years have produced some of the best results in its history. Investors thought its business was saturated and yet all these new endeavors suggest it's just getting started.
If you value Starbucks like Green Mountain Coffee Roasters (Nasdaq:GMCR), it's indeed priced to perfection. If on the other hand you value it based on the business it could become 5-10 years down the road, it's more than reasonably priced at this point.
Five years from now you'll look back on having paid $60 per share--and be glad you did.
At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.
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