Starbucks: Buy Now, Make Easy 40%
If you are looking for a stock that won't be disrupted by AI in the long-term and will keep compounding, Starbucks is now an amazing opportunity!
đĽLetâs Get Started!
Everybody in investing wants to be like Warren Buffett, I wanted to be like Warren Buffett and probably you wanted to be like Warren Buffett⌠However, have you ever thought about what sets Warren Buffett apart from other investors?
Whenever I ask this question to myself, one image appears before my eyes:
Look at that: Vertical line is annual outperformance relative to S&P 500 and the horizontal one is the number of years. There are many people who delivered better outperformance than Warren Buffett, but nobody has ever done it longer than Buffett.
Buffettâs Berkshire has had a compounded annual gain of 19.8% from 1965 to 2022, compared with 9.9% for the S&P 500 during the same time.
The question is how he has done it for so long? He answers the question himself:
He buys businesses that will be around 20 years from now and wonât be disrupted by the technology.
This is why Starbucks is an amazing business.
AI wonât disrupt it.
Internet wonât disrupt it.
You donât need to worry that some genius in MIT will invent better coffee.
Starbucks is a type of stock that will compound for decades to come and make you immensely rich if you manage to buy it at appropriate prices.
I think the price is appropriate now!
Letâs dive in why this is the right time to buy Starbucks!
What you will read:
1. Understanding the Business
2. Moat Analysis
3. Fundamental Analysis
4. Valuation
5. Conclusion
đđ Key Takeaways!
đŻ Starbucks is an amazing company that wonât be disrupted by the rapid technological development.
đŻ It has become a part of a lifestyle for many people around the world. Itâs brand is the only globally recognized coffee shop brand in the world.
đŻ Despite the simplicity of the core business, Starbucks recently diversified the ways it makes money like loyalty program, licensing, partnerships etcâŚ
đŻ Itâs fundamentals are rock solid. Negative equity is offset by immense earning potential and high certainty of the future earnings.
đŻ Even on the most conservative assumptions, the company is around 40% undervalued.
âUnderstanding the Business
How does Starbucks make money?
So easy right? By selling coffee of course.
It owns and operates thousands of coffee shops across the world. Itâs very straightforward and easy to understand. However, stopping here would be a very crude understanding of Starbucksâ business model. As investors, we need to better understand how the business makes money. So, letâs dig deeper into Starbucksâ revenue stream.
âĄď¸Physical Store Sales
The primary way that Starbucks makes money is through the sale of its coffee and other beverages. Starbucks has a wide range of drinks on its menu, including hot and cold coffee, tea, and specialty drinks like lattes and frappuccinos. The company also sells a variety of food items, including pastries, sandwiches, and salads.
âĄď¸Packaged Products
In addition to its physical stores, Starbucks also generates revenue through its packaged coffee and beverage products. These products are sold in supermarkets, grocery stores, and other retail outlets around the world. Starbucks also has partnerships with other companies, such as Nestle, to produce and sell Starbucks-branded coffee products.
âĄď¸Loyalty Program
Another way that Starbucks makes money is through its loyalty program, Starbucks Rewards. Customers who enroll in the program can earn points for every purchase they make at Starbucks, which can be redeemed for free drinks and food items. The program also includes special offers and discounts for members.
âĄď¸Licensing & Partnerships
Starbucks also generates revenue through licensing and partnerships. The company has partnerships with other businesses to operate Starbucks-branded locations in airports, college campuses, and other locations. Starbucks also licenses its brand and products to other companies for use in their own products, such as ice cream and single-serve coffee pods.
âĄď¸Investments
Finally, Starbucks makes money through its investments. The company has invested in a variety of businesses, such as juice and tea companies, and has partnerships with companies in the tech industry. These investments and partnerships provide Starbucks with additional streams of revenue.
Overall, Starbucks generates revenue through a combination of the sale of its beverages and food items, its packaged coffee and beverage products, its loyalty program, licensing and partnerships, and investments.
đ°Moat Analysis
Now thatâs the killer question: Does Starbucks have a moat?
Letâs ask the generic question then: Would you be able to displace Starbucks as the global leader in coffee shop business if you were given $50 billion (half of Starbucksâs market cap)?
I donât think so. I wouldnât be able to do it.
Why? Itâs simple.
Starbucks is much more than a coffee chain right now. Itâs a pop culture element. In the US, itâs not a high-end coffee shop anymore but itâs still the place where people meet with friends.
In Europe, itâs one of the most American things and represents the American lifestyle.
In poorer countries of the East, itâs still high end, itâs where more westernized and upper-intermediate class people meet.
Itâs perhaps the only coffee shop brand that is recognized at every corner of the world. Itâs the only truly globalized one.
Look at the above picture. There is no second coffee shop brand that girls are so proud to show to the camera. Itâs not just a coffee, itâs a lifestyle item.
You canât build this just by investment in a short period of time. Building a culture and lifestyle around a business takes deliberate planning and implementation of a strategy for a very long time.
On top of all above, add the fact that Starbucks is technology proof. It can utilize AI to enhance efficiency in its operations but AI doesnât pose an existential threat to Starbucks. No matter what happens in technology, people will keep drinking coffee 20 years from now in the same way they drink today.
In short, Starbucks has a wide moat that protects it against both competitors and technology.
If you own Starbucks, you can sleep well without worrying that AI will take your profits!
đFundamental Analysis
âĄď¸Growth
I always start fundamental analysis with revenue growth.
Why revenue growth? Why not look at EPS growth? Simple explanation is that itâs mainly the revenue growth that captures external growth of the business. There are many ways to grow EPS, mainly cost cutting, but for revenues to grow you should either sell more items to the same people or sell the same items to more people, simple as this.
My benchmark for growth is 10%. I expect revenues to steadily grow at least at 10% CAGR. Starbucks meets this condition, with a caveat.
Starbucks steadily grew revenue in the last 10 years, except 2020. Remember, at the time most of the Starbucks stores around the world suffered from months of shut-downs and most stores in its growth engine China remained closed for the most of 2019-2020.
Despite these headwinds, Starbucks managed to grow revenue around 7% in 2019 and the revenue declined just 11% in 2020 despite the long and widespread shutdowns. In the three years following 2020, Starbucks grew revenues at 16% CAGR. This is definitely remarkable.
Starbucks is a consumer discretionary that behaves like a consumer staple.
Why? Simple:
1) It can easily pass costs to consumers.
2) It can raise prices in inflation.
3) Many consumers donât cut back on Starbucks even in an economic downturn.
Moreover, Starbucks is expanding fast globally. It added around 2,000 new stores globally in 2023. Further, it opened 780 net new stores in China, reaching just over 6,800 stores in the country. Management expects that it will reach 9,000 stores in China by 2026.
Note that, despite the robust international expansion, there are still ample growth opportunities. India and most of Eastern Asia are still largely untapped. Given that India and most other Asian economies deliver robust economic growth, itâs not unreasonable to think that Starbucks will expand aggressively in these markets in the next decade.
Thus, I believe Starbucks can sustain at least 10% annual revenue growth for the next decade.
âĄď¸Financial Position
Starbucksâ financial position is rock solid.
Last year, it earned $5 billion before interest and taxes and it carries just over $24 billion in debt. This gives it Debt/EBIT ratio just under 5, which means it can pay all the debt in just under 5 years.
More important than this, its EBIT covers its interest expense more than 10 times.
âĄď¸Efficiency
Charlie Munger stressed the importance of Return on Equity as long as he was alive.
Why? Because in principle, you shouldnât expect to make more money on your investment than the underlying company makes on its own money. If its ROE is around 5%, you shouldnât expect you can make 10% on your investment. It can happen, but you shouldnât expect this.
Thus, in principle, higher the companyâs return on its own equity, higher your returns on your investment will be.
In Corporate America, average ROE is 12%. So you are looking above 12% while choosing your investments.
But⌠There is a problem here. Starbucks operates with negative equity. What does this mean?
Normally, for a conservative investor, this is an unforgivable sin. But there are exceptions. For a company to operate without positive equity, it needs to meet the following conditions:
Strong earning power
High certainty of future earnings
If the earning power of the company is so strong and certain, it can afford to operate without a positive equity. There are several companies in the world that can do that: Coca-Cola, Pepsi, McDonalds⌠Starbucks is one of them.
If something divinely bad doesnât happen, people will keep drinking coffee and Starbucksâ position in the market wonât be disrupted by AI. Thus, its earning power and certainty of the earnings are very high. It can afford to operate without positive equity.
But how are we going to know whether they are employing capital effectively then? Buffett recommends using Return on Assets against the same benchmark of 12%. As of April 2024, Starbucksâ ROA is 13.8%, which is satisfactory.
Return on Investment is even better: 21%.
Despite operating with negative equity, Starbucks gets a satisfactory grade from capital employment.
đValuation
Two factors above that allow Starbucks to safely operate without a positive equity base, also makes valuation pretty straightforward for the company.
Its earnings are stable, and certainty of earnings are high. This is the dream scenario for business valuation. These two factors make past data highly dependable, meaning we can use past data to forecast future earnings of the business.
In the last 10 years, Starbucks grew earnings per share from $1.35 in 2014 to $3.58 in 2023. This gives us 10.7% annual compounding growth rate.
Letâs be a bit conservative and say it will grow earnings 10% annually until 2030. Now, letâs get an appropriate multiplier. For this, I suggest looking at the median PE and then being a bit more conservative than that.
In the last 10 years, Starbucksâ median PE was 29. Let us be a bit conservative and determine 24 as the appropriate multiple.
In this case, Starbucksâ 2023 year end EPS of $3.58 will compound to $6.34 in 2030 and multiplying it with 24 will give us a price target of $152, 76% upside from the current price of $86.
Even if you are more conservative and apply 20 as the appropriate multiple, you will get a $126 price target, 46% upside potential.
As you see Starbucks is highly undervalued now and it offers +40% return, which is more than adequate.
đConclusion
Starbucks is a gem.
Itâs not just a coffee company, itâs also a lifestyle business. For many people around the world, going to Starbucks for coffee or meeting with friends at Starbucks means something more than coffee.
Immense earning power and high certainty of the earnings make it easier to value the company and even if you behave extremely conservative in your assumptions, you have around 40% upside potential.
Such good companies like Starbucks donât frequently get deeply discounted; when they do, you have to be brave and act decisively.
Warren Buffett? Never heard of him. Great write-up, Starbucks is a position I hold dearly.
Yes! Starbucks in the USA is not just about coffee; it's much more than that. It's essentially a lifestyle.
When people think of coffee, Starbucks immediately comes to mind.I am from Mexico, and in emerging economies like you mentioned, Starbucks is seen as a luxury.
We go there to meet people and hang out, and indeed, we do just that.
Their loyalty program is incredible! And as you mentioned, AI đ¤ can't replace their business model
Really great article!