Why Starbucks Stock Is Worth Its Premium Valuation

  • Starbucks stock carries the reputation of being priced at a high premium.
  • That said, with its strong growth and solid margins a premium shouldn't scare away investors.
  • With an aggressive international growth plan, finding the true intrinsic value can be difficult even for a company this size.

There is a common perception among investors that Starbucks (NASDAQ:SBUX) stock is trading at a very high premium. While I agree that argument can be made, Starbucks stock is a good choice in today’s volatile markets. As you can see below, Starbucks has significantly outperformed the S&P over the last year, and for good reason.

SBUX stock price chart

Starbucks stock price chart by amigobulls.com

Starbucks has built an empire in the restaurant industry and still has significant growth on the horizon. For the fiscal year 2015, revenue was up 16.5%, which was higher than the 10.5% they saw in 2014. Their 3 year annualized growth rate is 13%, compared to the industry average of 8.3%. With the company planning to open 500 stores in China every year until 2021, they have an aggressive strategy to extend their growth rate in the years to come.

Below I’ve outlined a DCF which shows the growth rate of FCF over the next 5 years, scaling down eventually. For the terminal growth rate, I've used 3%. I've used a WACC of 9%, with a market return rate of 11%, a risk-free rate of 3%, and a beta of 0.78. The increases in FCF are due to a combination of continued topline growth as well as small consistent improvements in Starbucks' operating margins.

SBUXdcf

As you can see, I have arrived at a value of equity of $73.7 billion. This is 14.5% below the company’s current market capitalization of $86.2 billion. I'll revisit that thought later. That apart, as you can see, Starbucks has a negative net debt, which is another positive for investors as the company doesn’t face the burden of being heavily leveraged. This is one reason Starbucks has a strong net margin of 12.5%, and doesn’t have to worry about financing its growth. McDonalds (NYSE:MCD) operates at an impressive margin, but has a debt/equity ratio of 3.4. Starbucks' balance sheet stands out from the competition having smaller debt and strong financial liquidity. Nevertheless, from this DCF Starbucks looks as if it might be trading at a pricey valuation.

From a comparable standpoint, Starbucks trades at a PE of 35.8. Given the size of Starbucks, investors have a tendency to compare this to the S&P 500 average which is only 18.1, or McDonalds which is 24.4, but neither would be a fair comparison. Starbucks is growing faster than its industry and still trading at a PE below the restaurant industry average of 42.8. McDonald’s has strong fundamentals and is a great core stock, but will not be priced at a deserved premium like Starbucks which is still experiencing double digit growth. I would compare Starbucks PE to a company more like Chipotle Mexican Grill (NYSE:CMG) which is a growth stock and has a PE of 33.5. This shows Starbucks' valuation in a more respectable light given the company's very strong fundamentals.

Conclusion

Most DCF models will probably not be nice to Starbucks given that future growth on top and bottom lines is still a little too unpredictable. But what we know for sure is that Starbucks is a growth company and should be valued like one. With double digit growth and plans to push for significant international expansion, Starbucks can offer much upside for investors looking for a growth play with less risk. Starbucks stock may be trading at a premium for some value investors, but what the investment offers can make that premium well worth the price.

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Comments on this article and SBUX stock

user profile picture
harshal.patel.1
bearish
You need to be more thorough. Starbucks in growing in China (500 stores per year).

Are gross margins in China stores higher, lower or equal to gross margins at US stores?
If their growth is coming in low margin markets, then their multiple is not justified.

The current risk free rate is nowhere near 3%; where did you even get that number from?

Comparing stocks by P/E ratio is silly; you need to look at store mix (McDonald's has lot of franchises, Chipotle has none), net sales, etc.
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user profile picture
harshal.patel.1
bearish
Also their EPS has not grown in 1 year. How does that justify their high P/E?
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