Starbucks financial performance and stock valuation analysis

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 sheet in 2007, but this remains minor portion of the firm's capital structure. 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.

Strategic Analysis

Starbucks responded well to investor concerns about its ability to maintain growth and began to shift the company's operating strategy. It has not reduced its debt, but the debt level is fairly low. What Starbucks has done is embark on a multi-faceted response to the economic and competitive pressures that it was facing. In doing so, the company restored investor confidence. The downturn in the company's fortunes resulted from a near-perfect storm of expanding too quickly, a sharp increase in competition and economic downturn. Starbucks has been able to address these issues without sacrificing the brand power that it has built over the past couple of decades.

The reality is, however, that the company is moving into the maturity stage of its business cycle. Most of its strategic endeavors, including the new 15th Avenue brand and ongoing expansion in Asia and the Middle East, continue to reinforce the idea of Starbucks as a growth company. Given the importance of the domestic market to revenues (72.5% in 2008), the growth story is actually a small part of the total business. Starbucks needs to be viewed more as a mature company by investors. The current price for the company's stock gives it a price/earnings ratio of 26.63, which is more oriented with a growth company. The dividend yield is just 1.91%, but represents nearly half of the company's earnings. This indicates that the stock price is probably overvalued at present.

Conclusion

Starbucks has done an admirable job of restoring fiscal stability and investor confidence. This, however, has reflected in a strong rise in the company's stock price. The company's financials are good, as are its business prospects. However, the 2010 run-up in Starbucks stock does not mirror any run-up in the broader market and indeed current economic indicators remain unfavorable for such a run-up. It is recommended that, despite positive sentiment with respect to the company and its recent performance, Starbucks stock is rated "hold." A "buy" rating would be inappropriate, as the company is no longer undervalued. It is not substantially overvalued, as the company is still attempting to grow, but the economic situation and domestic market situation indicate that growth at Starbucks will be relatively slow in the short run. In the long run, more markets will enter maturity. As yet, geographic diversification is the only real diversification strategy with any staying power at Starbucks. As a result, growth prospects are restricted to those associated with the general economy, and with improved managerial performance. There is no reason to be concerned with Starbucks stock -- the company has demonstrated the ability to respond well to crisis -- but there is no cause for the market's current optimism about the company either. With that in mind, a "hold" recommendation is the most appropriate.

Works Cited:

Allison, M. (2010). Starbucks tests new names for stores. Seattle Times. Retrieved October 24, 2010 from http://seattletimes.nwsource.com/html/localnews/2009479123_starbucks16.html

Groom, N. (2007). Starbucks shares hit 18-month low -- time to buy? Reuters. Retrieved October 24, 2010 from http://www.reuters.com/article/idUSN1541189820070515

MSN Moneycentral: SBUX. (2010). Retrieved October 24, 2010 from http://moneycentral.msn.com/investor/invsub/results/hilite.asp?Symbol=SBUX

Starbucks 2005 Annual Report. Retrieved October 24, 2010 from http://library.corporate-ir.net/library/99/995/99518/items/178286/Annual_Report_2005_part2.pdf

Starbucks 2006 Annual Report. Retrieved October 24, 2010 from http://library.corporate-ir.net/library/99/995/99518/items/230297/10K_A_10K.pdf

Starbucks 2009 Annual Report. Retrieved October 24, 2010 from http://media.corporate-ir.net/media_files/irol/99/99518/SBUX_AR.pdf

Yahoo! Finance. (2010). Starbucks 5-year chart. Retrieved October 24, 2010 from http://finance.yahoo.com/echarts?s=SBUX+Interactive#chart1:symbol=sbux;range=5y;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=on;source=undefined