Due to Starbucks' (NASDAQ: SBUX) operations in the restaurant industry, analysis of the company's financial ratios must take into account a few important aspects. 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.
Fixed-Charge Coverage Ratio
Checking the financial health of Starbucks is an important step in ratio analysis. The company has over $2.9 billion of debt sitting on its books, and it must have sufficient funds available to cover its contractual obligations payments. Besides banks' debt, Starbucks is also a party to numerous operating leases; the company does not own its operating premises, but rather rents them. As of Sept. 28, 2014, Starbucks has operating leases for about $5 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 U.S. generally accepted accounting principles (GAAP) do not require capitalizing them.
The fixed-charge coverage ratio looks at the company's ability to cover its fixed charges, such as interest and lease payments, with its earnings. As of Sept. 28, 2014, based on the annual rent expense of $974.2 million, interest expense of $64.1 million and earnings before interest and taxes (EBIT) of $3,081.1 million, Starbucks' fixed coverage ratio was 3.9. While there is no standard for this ratio, the higher fixed-charge coverage ratio is, the more cushion Starbucks will have to cover its fixed charges. In comparison, McDonald's Corporation has almost the same fixed-charge coverage ratio of 3.95 as of Dec. 31, 2014.
Another important ratio to assess a company's financial health is its debt/equity ratio (D/E ratio), which shows the company's degree of leverage and risk. While most analysts consider only 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 Sept. 28, 2014, Starbucks' D/E ratio without operating leases stands at 38.8%, while the company's D/E ratio with operating leases is 133%.
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 being cost efficient 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. As of June 28, 2015, Starbucks' operating margin stands at 18.9%, which is much higher when compared to the operating margin of 5% for the restaurant and bars 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 June 28, 2015, Starbucks' net margin was 14.6%, which is significantly higher than the industry's average of 3.2%.
Return on Equity
Looking at Starbucks' return on equity (ROE) is another important step, as it reveals how much income the company has generated with funds provided by its equity shareholders. Firms with strong economic moats typically have higher ROE compared to rivals. As of June 28, 2015, Starbucks' ROE stands at 49.3%, which is significantly higher than its competitors' average return of 10.7%.
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 look into 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 obligation. Consistently high ROIC in excess of 15% is indicative of a strong economic moat. As of June 28, 2015, Starbucks has an ROIC of 32.35%.
One short-coming of this ratio, though, 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.