Finance Starbucks is engaged in the quick service food industry, primarily focused on coffee and related snacks. The company has come under strong competitive and economic pressures recently, and this has impacted its performance. However, Starbucks has turned around its financial performance in the past year, which has restored investor confidence in the company.

Starbucks is both liquid and solvent. In the past year or so, they have improved their liquidity and solvency ratios. They added long-term debt to their balance sheet in 2007 but have not increased this debt since. The company's margins have slowly eroded over the past five years, mainly due to a decline in customer side pricing power as the result of competition from low price providers. Starbucks has also seen its efficiency erode, likely due to expanding into less-saturated markets around the world in search of growth. Overall, however, the company's financial performance has been strong.

Starbucks stock is more volatile than the market, and this is related to a decline in investor confidence in 2007 when the market was high and a restoration of that confidence over the past year while the market flatlined. The company's stock at present is valued more as a growth stock, yet the bulk of company revenues come from mature markets. While the company's performance is strong, its valuation does not match its operating reality. The company is attempting to continue growth, but is faced with only moderate growth prospects. As a result, Starbucks equity is presently slightly overvalued. This leads to a recommendation of "hold."

Introduction

Seattle-based Starbucks Corporation is a leading coffee shop chain. The company operates in the quick service food sector, competing against a wide variety of companies. The company's competitors range from other coffee shop chains to fast food outlets to other caffeinated products such as energy drinks to the broader food service industry. Through much of the 1990s and 2000s, Starbucks enjoyed rapid growth, but there is evidence to suggest that the company's core market in North America is reaching maturity. In the past decade, Starbucks has focused significant attention on overseas expansion and revenue diversification in order to maintain growth. However, recent challenges to the company's dominant market share from equally powerful players such as McDonald's and Dunkin' Donuts combined with two years of recession has cut into the company's revenues.

This paper will examine the financial situation that Starbucks finds itself in today. Ratio analysis will be used to understand the company's short- and long-term situation, with a focus on liquidity, solvency and operating efficiency measures. The project will also focus on the company's stock performance over the past several years. A recommendation will be delivered with respect to the investment quality of Starbucks' equity. This analysis will be undertaken on the basis of the firm's financial performance, strategic situation and the degree to which these have already been priced into the company's stock. The primary resources for this report are the Starbucks 2009 Annual Report and the figures contained on MSN Moneycentral. The latter reflect revised figures, and are therefore more up-to-date than the older annual reports that can be found online, which do not contain revised data. In addition, news articles and press releases concerning the company's recent activities and strategic situation will be utilized in the analysis.

Financial Performance

The first element of financial performance that will be analyzed is the liquidity situation. Liquidity ratios provide an indication of the company's ability to meet its financial obligations for the next year. The main liquidity ratios are the current ratio, quick ratio, cash ratio and times interest earned. The liquidity ratios for Starbucks are as follows:

2009

2008

2007

2006

2005

Current

1.28

0.79

0.78

0.79

0.98

Quick

0.59

0.29

0.33

0.35

0.40

Cash

0.42

0.14

0.20

0.23

0.25

X Int Earned

14.3

9.4

27.7

The company's liquidity has been fairly stable for the past five years, but improved significantly in 2009. This was the result of a concerted effort on the part of the company to adjust from a growth-oriented balance sheet to a mature industry balance sheet. Of note was the introduction of long-term debt to the balance sheet in 2007, which brought down the times interest earned. The times interest earned improved in 2009 on the basis of both an improvement in EBIT and a reduction in interest payments on floating rate debt. Overall, Starbucks is liquid and their liquidity situation has improved since 2008.

The next ratios are the solvency ratios, which measure the company's ability to meet its long-term debt obligations. These ratios revolve around the level of debt that the company has. The debt ratio (capital structure) and the debt-to-equity ratio are the key measures. For the past five years, they are as follows:

2009

2008

2007

2006

2005

Debt ratio

0.45

0.56

0.57

0.49

0.40

LTD/E ratio

0.18

0.22

0.24

0

0

These figures indicate that Starbucks has a relatively low degree of leverage. The company introduced long-term debt to its balance...

Starbucks has also taken steps to reduce the debt component of its capital structure from its highs in 2007-2008.
The next set of measures reflects the company's pricing power. The margins the company earns reflect its ability to control prices from suppliers and to consumers. The ability to control prices is indicative of the company's ability to adjust to different market circumstances and continue to meet its obligations to creditors and shareholders under adverse circumstances. The margins for Starbucks are as follows:

2009

2008

2007

2006

2005

Gross

20.7%

19.1%

23.3%

24.6%

25.0%

Operating

5.7%

4.8%

11.1%

11.4%

12.2%

Net

4.0%

3.0%

7.1%

7.2%

7.7%

These figures indicate that Starbucks has lost some its pricing power of the past couple of years. The company appears to have lost much of this on the customer side (gross margin). This loss corresponds with increased competition, much of it based on price, from McDonald's and Dunkin' Donuts in the domestic market. The company also had lower operating costs during 2005 and 2006 and the increase in these expenses also had an impact on the company's overall margin.

The company can also be measured on its efficiency measures, which indicate the ability of the company to utilize its resources efficiently. These measures include the asset turnover, the inventory turnover and the accounts receivable turnover. These ratios for Starbucks are as follows:

2009

2008

2007

2006

2005

Asset Turn

1.73

1.88

1.92

1.96

1.84

Inv Turn

11.4

12.1

10.8

9.9

9.8

A/R Turn

32.5

33.7

36.7

37.5

38.6

What these figures indicate is that Starbucks has become less efficient over the past few years. This can likely be attributed to a couple of phenomenon. The first is the slowdown in revenues, which affected the top line of the asset and receivables turns in particular. The other factor is that as the company's North American business first became mature and then became subject to intense competition, Starbucks has become more focused on overseas expansion. As the company's global network has been extended, it will naturally lose some efficiency. Only when foreign nations begin to reach the same saturation levels as North America will the company be able to have North America-like levels of efficiency.

For investors, returns are another measure of the company's ability to convert its resources into revenue. There are three basic measures of return -- equity, assets and investment. In particular for the investment decision, these returns are measured against the industry averages. The other measures above are better used in a company-specific context, as there are significant differences between Starbucks and most of its industry peers, such as the degree to which food and global markets are emphasized, and the degree to which Starbucks is subjected to the global commodities market for its key input. With respect to the investment decision, however, returns are a good measure that can be used across firms. The returns on inputs for Starbucks are as follows, sourced from MSN Moneycentral:

Current

Industry

5-Year Avg

Industry 5-year

ROE

25.8

24.6

20.7

19.7

ROA

14.2

13.9

10.5

10.4

ROI

19.9

19.3

16.7

16.0

What these figures indicate is that Starbucks narrowly outperforms the industry, both at present and over the past five years. Starbucks' current return ratios exceed the firm's historical averages and have maintained a level above the industry average both in the short-term and long-term. This indicates a high quality of management that is superior to their peers, if only slightly, and it also indicates improved performance in the short-run, despite the economic slowdown and increased competition.

Share Price Analysis

For the investment decision, a share price analysis must also be conducted. While it is critical to understand the company's financial performance over the short- and long-term, this must be balanced against the cost of investing in the company. The company's beta is 1.29, which indicates that the stock price is 29% more volatile than the general stock market. Such a beta can be associated with a growth company, but it is also common for firms that are especially susceptible to shocks in their business. With Starbucks, there was substantial investor concern about the firm's deteriorating financial position in 2007 and 2008, which was related to the closing of stores, shrinking revenues, increased competition (Groom, 2007).

At that point in time, Starbucks shares were at $28.39 but the stock market had not yet fallen. This volatility contributes to the company's relatively high beta today, as indicated with the 5-year Starbucks chart is overlaid with a 5-year S&P 500 chart (Yahoo! Finance, 2010). The firm's rise from this trough is also not mirrored in by movements in the S&P, so firm-specific risk has been affected by a loss of investor confidence in 2007…