Starbucks Store at Vivocity Singapore

Starbucks is expected to release fourth quarter earnings on the 28th of October. The company is a global food and beverage company whose performance is tagged very closely to the economic performance of the countries in which the company is operating in. With the global economy opening and travelling picking up, I have decided to look deeper into the company to see if there are any opportunities for us to explore.

About the Company

Starbucks Corporation, together with its subsidiaries, operates as a roaster, marketer, and retailer of specialty coffee worldwide. The company operates through three segments: Americas, International, and Channel Development. Its stores offer coffee and tea beverages, roasted whole bean and ground coffees, single-serve and ready-to-drink beverages, and iced tea; and various food products, such as pastries, breakfast sandwiches, and lunch items.

The company also licenses its trademarks through licensed stores, and grocery and foodservice accounts. The company offers its products under the Starbucks, Teavana, Seattle’s Best Coffee, Evolution Fresh, Ethos, Starbucks Reserve, and Princi brand names. As of October 29, 2020, it operated approximately 32,000 stores. Starbucks Corporation was founded in 1971 and is based in Seattle, Washington.

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A Starbucks’ Store

Segments that the Company is Operating in

Revenue Components (Annual Report 2020)
Revenue 2020 vs 2019 (Annual Report 2020)
Company-operated store data for the year-ended September 27, 2020 (Annual Report 2020)
Licensed store data for the year-ended September 27, 2020 (Annual Report 2020)

In fiscal year 2020, Revenue from company-operated stores accounted for 81% of total net revenues. From here we can see that company-operated stores is a more lucrative model compared to licensed store’s format. Revenues from licensed stores accounted for 10% of total net revenues in fiscal 2020.

From the above tables, we see that he company has added company-operated stores across different geographical regions except for Canada. Rate of growth is c. 5% for year 2020.

For new stores opening, fiscal year 2021, the management expected 1,100 and all of these will be international. In the US, they have opened about 800 new stores but at the same time, they have also closed about 800 stores and that is a nett zero for US market.

During the 4th quarter conference call, management will most probably provide outlook for fiscal year 2022. The company had said that its long term comparable store sales growth is going to be in the range of 3% to 4% per year. New store openings are expected to add 2% to 3% to that. As such, the stable equilibrium long-run growth rate is expected to come in at the range of 6% to 7%. If management during the next conference call gives outlook for 2022 higher than the above, there is still room for the company to improve as it bounces back from the covid crisis. This is what I am expecting for the company as they are still not operating at full strength with various countries and US in different stages of movement control.

Supply Chain Disruption, Labour Constraints – Threats turned Opportunities through Technology

As the company is very dependent on human labour, the recent spike in labour cost may impact revenue negatively. Supply chain disruption may also negatively impact on revenue as products within stores are unavailable for sale. The company is investing in technology to reduce its reliance of human labour for its operations. One example is mobile ordering in which customers can order their drinks or food online or even through their mobile phones’ app, and then picked up their orders at the stores or delivered to their cars. With this, starbucks reduces the need to have someone taking orders from customers. Recently, the company has introduced a new store format, Starbucks Pickup, to enhance the “on-the-go” customer experience and improve operating efficiency across Starbucks stores in certain major metropolitan areas in the Americas. New store formats, such as Starbucks Pickup, are suitable for customers who prefer to order ahead and pay through the Starbucks Mobile App for pick-up.

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In major international markets, the company continues to invest in technology and establish partnerships with third parties with relevant expertise to increase digital adoption to provide convenience and elevate the customer experience. In China, the introduction of Starbucks Now stores enables a seamless integration of physical and digital customer touchpoints. Orders may be
placed in advance through the Starbucks Mobile App or Starbucks Delivers and can be conveniently picked up by customers and delivery riders in these express retail format locations. These strategies align closely with rapidly evolving customer preferences, including higher levels of mobile ordering, more contactless pick-up experiences and reduced in-store congestion, all of which naturally allow for greater physical distancing.

The covid crisis had accelerated the company’s adoption of technology in their operations. Without the covid, most probably some of these new initiatives would not have gain traction in such a short time. These new initiatives will most probably enhance the company’s competitive advantage internationally as we gradually recover from the pandemic.

Macro-environment providing Tailwind

The company is operating in the consumer discretionary space. As such, it would be prudent to see where are we economically. I believe we have already passed the worst of the pandemic. Globally, countries are starting to opening their countries to leisure travel. As more data from the virus emerged over time, medical technologies or solutions will make covid more manageable and less dangerous. Global pharmaceutical companies have received massive funding during this period of time for their research into the coronavirus. All the above are positive for the company.

Central banks have pumped in record liquidity into various economies to prevent a major financial crisis since the onset of the pandemic back in 1Q2020. This liquidity have started to cause some inflationary worries but of course, the FED had stated its stand that this inflationary pressures are just transitory. Supply chain disruption have indirectly contributed to inflation in the last couple of months. Cost of transportation have gone up due to a shortage of labour as a result of human movement controls. As the world opens up, these issues should ease. The world should transit into the economic expansionary stage soon (~1 year).

As global economy starts to grow, it will benefit Starbucks as consumption starts picking up. The company will also stand to gain substantially from an improving US economy.

U.S. economy's anticipated boom following the Great Recession derailed by  long-simmering factors, Stanford economist says

Key Risks

  • Worsening Covid conditions
  • Global Economic recovery speed post covid
  • International governmental and regulatory changes
  • International political relationship – i.e. US-China relations as China remains as one of the key market in the company’s expansion strategy
  • Supply chain disruption resulting in higher raw material costs
  • Cybersecurity and data privacy as the company uses technology to improve operations and enhance margins
  • Increase labour cost impacting profitability

Street Estimates

  • Q4 Revenue of $8.26 billion (+33.1%)
  • Total Revenue of $29.159 billion for fiscal year 2021 (+24%)
  • Earnings FY2021 at $3.702 billion (+2.8% pre-pandemic)
  • EPS of $1 (+96%)
  • Total EPS for FY2021 estimates from low of $2.966 to high of $3.71.

Things to Watch during the Next Conference call

  • Global Company-operated sales growth
  • Number of new stores opening
  • Outlook for FY2022
  • Comments on current operating environment – Supply chain and labour constraints

My Valuation

Assuming an average EPS estimate of $3.338 for FY2021, and a PE multiples of 44x (factoring in company’s ability to further digitalised operations, global economy reopening post-covid and company’s growth in-line with expectations), fair value of the stock is $146.87 (31.78% higher than friday’s closing price of $111.45).

Analysts’ Ratings

Analysts’ Ratings as of 16th Oct 2020

Technical Analysis

SBUX Daily Chart
MACD
RSI

Price broke its 200 days MA late in August 2020 and have stayed above it since then. Currently its hovering along its 200 days MA and interestingly, at the bottom of the uptrend channel too. The last time that MACD had hit this level was back during the onset of the pandemic. MACD is turning up, possibly heading towards the base-line. RSI is c.44 which is at the lower band and showing signs of strengthening forming higher lows.

Currently, the price is testing its 200 days MA. A breakdown below its 200 days MA is bearish and next support should come in around $107.

However, the 200 days MA is usually a good support level and watched closely by traders. It is possible that the price will bounce off this level and continues its climb back along its uptrend channel.

As Starbucks is reporting results on the 28th of October, which is about 9 market days away, and ex-dividend falls on the 10th of November 2021, I believe that prices will trend along current level for the time being. The results may provide catalyst for the price to ascend above its 200 days MA strongly (if the results beats estimates). Prices have fallen about 12% since July and thus, market is probably pricing in a negative reporting season for the company in view of economic data pointing to a slow down of the US economy.

My Views

I would take this opportunity to accumulate shares of the company in view of the positive macro tailwinds. Moreover, the company has a strong balance sheet and continued its share buyback even during the pandemic. Starbucks’ strong branding is a clear competitive advantage over its competitors internationally. Their strategic store locations globally gives them an advantage once a 100% reopening of global economies happened.

From a risk reward perspective, I will give it a 8.5 out of a 10. Let me know your comments below.

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