What Are The Best Ratios to Use to Analyze Starbucks?

Starbucks' (NASDAQ: SBUX) is a major player in the retail industry. An analysis of the company should include financial ratios that are most relevant to the company's financial standing and its industry. The company tends to rely heavily on operating leases, which represent Starbucks' off-balance-sheet obligations. Also, an analysis of the company's financial effectiveness must take into account Starbucks' financial leverage since the company has a substantial amount of debt on its balance sheet.

Key Takeaways:

  • The ratios used to analyze Starbucks should be take into account the state of the retail industry and the operating model the company has adopted.
  • Starbucks relies on operating leases, which are off-balance-sheet obligations, and carries a substantial amount of debt.
  • Six useful ratios to analyze Starbucks are the fixed-charge coverage ratio, the debt/equity ratio, the operating margin, net margin, return on equity, and return on invested capital.

Understanding the Best Ratio's to Analyze Starbucks

The following six ratios are useful indicators of Starbucks' financial standing compared to its industry competitors.

Fixed-Charge Coverage Ratio

Checking the financial health of Starbucks is an important step in ratio analysis. At the end of fiscal year 2019, the company reported over $11.17 billion in long-term debt. Companies must have sufficient funds available to cover their contractual obligations. In addition to bank debt, Starbucks has extensive operating leases because the company rents rather than owns its operating premises. As of September 2019, Starbucks had operating leases for about $9 billion, underscoring the importance of including rent expenses in the assessment of the company's financial health. Leases are similar to regular debt except that US generally accepted accounting principles (GAAP) do not require them to be capitalized.

The fixed-charge coverage ratio looks at a company's ability to cover its fixed charges, such as interest and lease payments, with its earnings. As of Sept. 29, 2019, based on the annual rent expense of $1,625 million, interest expense of $92.5 million, and earnings before interest and taxes (EBIT) of $4,317.5 million, Starbucks' fixed coverage ratio was 3.52, according to Stock Analysis on Net. While there is no standard for this ratio, the higher the fixed-charge coverage ratio, the more cushion Starbucks will have to cover its fixed charges.

Debt/Equity Ratio

Another important ratio to assess a company's financial health is its debt/equity (D/E) ratio, which shows the company's degree of leverage and risk. While most analysts consider only the book value of debt in their calculation of this ratio, some financial professionals also lump operating leases and minority interest into this calculation.

As of the end of fiscal year 2019, Starbucks had a debt-to-equity (D/E) ratio of 58.1%.

Operating Margin Ratio

As with any other business, Starbucks must generate profit margins and returns that are relatively higher than those of its competitors. Also, looking at Starbucks' profitability ratios over time provides a gauge of how the company is doing in terms of cost efficiency and generating returns that exceed the company's cost of capital.

Operating margin is one of the most important margin ratios for Starbucks. It provides more comparability against competitors whose reliance on borrowing to finance operations varies. Also, operating margin is indicative of the company's effectiveness from the standpoint of creditors and equity shareholders. For fiscal year 2019, Starbucks' operating margin stood at 15.4%, which is high when compared to the average operating margin of 5% or less for the retail industry.

Net Margin Ratio

Net margin is another crucial metric for Starbucks as it shows the company's effectiveness in covering operating costs, financing, and tax expenses. Unlike the operating margin, the net margin shows Starbucks' financial effectiveness from the perspective of its common equity shareholders only. As of March 2020, Starbucks' net margin was 5.48%, according to Gurufocus, which is higher than the industry's average of 2.17%.

Return on Equity

Return on equity (ROE) reveals how much income a company has generated with funds provided by its equity shareholders. Firms with strong economic moats typically have higher ROE compared to rivals. Starbucks's return on common equity as of June 2020 was 15%, according to Reuters.

Return on Invested Capital

Examining only the ROE may mislead investors; high ROEs can be achieved with a high degree of leverage. For this reason, analysts typically use another metric called return on invested capital (ROIC), which is calculated as after-tax operating income divided by invested capital. Invested capital represents total equity, debt, and capital lease obligations. Consistently high ROIC, in excess of 15%, is indicative of a strong economic moat. As of March 2020, Starbucks had an ROIC of 5.26%, according to Gurufocus.

One shortcoming of this ratio, however, is that it does not take into account any off-balance sheet financing Starbucks has, such as operating leases. One way around this issue is to capitalize and include operating leases in the calculation of the ROIC ratio.