[SBUX] [ Corporation]

St Andrews Investment Society

Starbucks Corporation [12/4/2019] [SBUX] An energized future for a dominant and dynamic company. Price ([9/4/19]) $75.20 Market Cap (bn) $92 Company Overview EV (bn) $80.57

Starbucks Corporation is a US based coffee company and coffeehouse chain. Founded in 1971 in Seattle, Washington, the [SECTOR] company has grown steadily since its inception. The company turned its first profit in 1980 and, even when the economic Price Target [$85.25] downturn of the 80s hit, continued to grow steadily upwards. It Investment Horizon [12m] opened its first international location in 1996 in Tokyo. Recent statistics from 2018 state the company now has 28,218 locations 24m performance: around the world. The company’s well-known logo and thousands of locations offer weary coffee drinkers a place they know just about anywhere; its seasonal offers, specialty Evolution Fresh , beverages, snacks and branded mugs and tumblers. Pre-packaged meals are always available to purchase when purchasing coffee. Starbucks also has products it sells in local grocery stores. Starbucks is also every looking to Market Data: adapt and change with the market, shown in its choice to focus on 52- Week Range [47.37-74.34] the Chinese market next, opening 600 net new stores every year Shares Out. (bn) [1.25] until 2022. The company has even partnered with Alibaba in order EV/EBITDA [11.1]x EV/OpFCF [6.75]x to find the best way to expand in their next targeted market. P/E [31.49]x Div./Yield [$0.36]/[2.8]%

Investment Rationale Financial Data: Revenue (bn) [42.72] Starbucks is an established company, being one of the most Revenue growth [10.4]% known companies within the retail coffee industry, with 13,983 EBITDA (bn) [7.26] licensed stores worldwide as of 30th September 2018. While the EBITDA growth [32.4]% barriers to entry to the retail coffee industry are only moderate as EBITDA margin [29.3]% at a localized level, small coffee shops can compete with the bigger brands, the larger incumbent brands have had years to Leverage: Net Debt (bn) [9.44] improve product quality, establish themselves in prime real estate Net Debt/EBITDA [1.3]x locations, create their own unique store ecosystem experience and Net Debt/Interest [55.5]x to gain favourable access to raw materials by building relationships with suppliers. Over the years, Starbucks has achieved significant economies of scale with superior distribution channels and supplier relationships. Starbucks is constantly trying to develop and diversify the products that they offer. Smart acquisitions of companies such as (tea products), Bay Bread (premium bread products) and Evolution Fresh (fresh products) has allowed Starbucks to offer a more diversified portfolio of products widening their potential consumer base and further differentiating themselves from their competitors.

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[SBUX] [Starbucks Corporation]

The company is stable in terms of profit and revenues. Total net revenues have increased 10 % to $24.7 billion in fiscal 2018. Starbucks stock prices have steadily risen over the last few years. Starbucks has an operating income of $3.8 billion as of 30th September 2018. The US economy has had strong steady growth over the last few years with 2.6 % growth in GDP in the 4th quarter of 2018. With Starbucks having 39 % market share in the US retail coffee industry as of 2018, it is likely that Starbucks will continue to grow within the US market, a market where they have very strong brand recognition and are continuing to add stores as part of their wider strategy. Starbucks is also expanding into developing markets with an increase of 1051 stores (either company-operated or licensed) in China/Asia Pacific between 1st October 2017 to 30th September 2018. In addition, Starbucks is also now exploring new streams of potential revenue, licensing the rights to sell and market Starbucks-branded products in authorized channels to Nestlé in the fourth quarter of fiscal 2018. In terms of risk, Starbucks is firmly aware of the volatility of the price of coffee. To address this issue Starbucks actively seeks to build strong relationships within the coffee supply chain, operating nine farmer support centers which focus on promoting the best practices in coffee production within coffee farming communities, ensuring not just the best coffee quality but also improved yields, further reducing risk in supply. Overall, Starbucks is a safe investment, one that is unlikely to yield a particularly high return, but also unlikely to yield a very low one.

Market Position

Starbucks is a worldwide coffee and beverage company. Apart from coffee shops it owns , Taza, and Teavana. Starbucks is the largest coffee company with Dunkin and Tim Horton’s 2nd and 3rd. Starbucks control 41% of the industry with the other two making a combined 68%.

Public comps:

EV/EBITDA Trailing P/E EPS

Starbucks 17.98 31.49 2.25

Dunkin 19.28 26.89 2.71

McDonalds 17.08 24.54 7.54

Wendy’s 16.49 9.21 1.88

Financial Position

Starbucks’s valuation is driven by revenue growth. Margins in the past 5 years have not significantly changed, but the top line has grown at an average of 14.5% year over year. This is in part due to the growing levels of disposable income in many of Starbucks core regions. A larger factor is a strategic expansion. 79% of Starbucks revenue comes from company operated stores and increasing the number of locations has boosted revenue significantly. Normally revenue growth at this level comes with margin decay, but Starbucks has been cutting employee hours and understaffing locations which is great for keeping the net profit margin around 15% for the past 4 years. When valuing Starbucks’s cash flows, we took a conservative approach with regards to noncash addbacks and cash from working capital. The firm is a unicorn in that it can grow revenue while decreasing it’s working

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[SBUX] [Starbucks Corporation] capital requirements. We know this is unsustainable, so we reduced it in the model, but it’s an important factor to recognize. In short, the valuation is driven by revenue growth. The exit strategy in the DCF assumes no multiple expansion, making this a very sound value play that requires little market support.

[Starbucks Corporation] - Financial Summary 16A-18A ([$m], FYE [Dec]) FY2016A FY2017A FY2018 LTM CAGR

Revenue 21,320 22,390 24,720 25,280 8% Growth 11.25% 5% 10.4% 2.2% EBITDA 5,310 5,480 7,260 5,340 17% Margin 25% 24.4% 29.3% 9.2% EBIT 4,280 4,411 5,950 3,959 18% Margin 20% 19.7% 24% 14.2% OpFCF 4,575 4,174 11,938 12,483 61.5% Margin 21.4% 18.6% 48.3% 49.3% Net income 2,819 2,885 4,518 3,028 26.6% Margin 13.2% 12.9% 18.3% 12%

Growth Prospects & Risks

Growth Prospects: Coffee is one of the fastest growing beverage categories globally, which is obviously a great macro trend for Starbucks. To capitalize on this opportunity, Starbucks has outlined an extensive growth agenda with several promising growth prospects to keep them on top of the coffee industry. First, in 2019 Starbucks is launching Starbucks Delivers in partnership with Uber Eats, to almost a quarter of their US stores while also expanding the service in China in partnership with Alibaba and Ele.me. Their delivery service has been very successful, reaching 2,000 stores in 30 Chinese cities, and they now look to replicate this success in more markets. Overall, the Chinese market is a huge growth prospect for Starbucks, as they are also debuting a first of its kind virtual Starbucks store in partnership with Alibaba. Their partnership with Alibaba is a great growth prospect, providing many more untapped opportunities in the Chinese market. Back in the US, Starbucks is expanding into Nitro Cold Brew, an area of the coffee industry with high consumer demand and great growth potential. Starbucks’ new partnership with Nestle also presents an incredibly attractive growth prospect as they are preparing for the global rollout of Starbucks At-Home Coffee portfolio. Starbucks and Nestle will be the only brands to have their own branded products that work on both Nespresso and Dolce Gusto at home coffee machines. Nespresso and Dolce Gusto’s install base is estimated to be more than any other single serve system in the world, providing a huge opportunity to reach new customers.

Risks: The first obvious risk that Starbucks faces is the threat of a US economic downturn, as coffee is a product that requires discretionary spending, so if the economy takes a turn for the worst, so too will

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[SBUX] [Starbucks Corporation]

Starbucks sales. However, a US economic recession is not forecasted until at least 2020, mitigating the risk to our potential investment in the company. Furthermore, Starbucks is heavily reliant on the US market, as well as their growth in the Chinese market, making current US-China relations a macro risk for the company. If relations between these two countries were to take a turn for the worse, restrictive regulations, potential boycotts, and a growth in anti-Americanism would be a major risk to the companies’ growth in China. Starbucks also faces political risk in the US, with the founder and ex-CEO strongly considering running for president. Especially in the current emotionally charged political climate in the US, Schultz’s running could spark some anti- Starbucks sentiment. There is also a growing trend of eco-awareness, which would pose a threat to Starbucks and their use of plastic and other single use packaging. However, Starbucks has done an excellent job getting ahead of this trend, as they have plans to phase out single use plastic, such as straws, replacing them with e-coin friendly alternatives. Finally, there is also always the potential risk of supply chain disruption, especially because Starbucks sources their products from a wide range of domestic and international sources. Starbucks also sources from developing countries, which are more highly at risk for political changes or even the effects of climate change, thus possibly affecting production.

Management Structure & Integrity

Though management in Starbucks has gone through major changes in recent years, its values and goals are the same: to continue the company’s core strategies for growth and to keep Starbucks a welcoming environment for customers worldwide. Former CEO Howard Schultz is especially vocal about issues in inclusion and making Starbucks available to everyone. Recently, Schultz decided to step down from both his roles as CEO and executive chairman to pursue his political motivations in June of 2018. Kevin Johnson, who previously held several executive positions at Microsoft and has been on the board of directors at Starbucks since 2009, replaced Schultz as CEO. To continue Starbucks’ growth strategy, Johnson announced that the company will “thin out its executive ranks as part of a corporate reshuffling” to help the company expand internationally, specifically in “fast- growing markets such as China”. This announcement comes due to stagnant sales in the United States. In the high range, managers of local stores can have an average bonus of 25,000$ while top- level executives have an average compensation of 7,030,000$.

Shareholder Structure

Howard Schultz, the founder and former CEO, is the single largest shareholder of Starbucks holding 33 million shares directly and 1.7 million shares indirectly through trusts. Mellody L. Hobson the president of Ariel Investments LLC, a Chicago based investment firm, is the second largest shareholder with 246,000 shares directly and 283,146 shares indirectly owned by her. John Culver, president of global retail at Starbucks, is the third largest shareholder with 366,402 shares held directly by him. Clifford Burrows, Starbucks’ group president of Siren retail, is the fourth largest individual shareholder with 248,225 shares. 8.07 million shares are traded and the stock has a BETA of .4877 making it a defensive stock. 26.40% of shares are held by the top holders. The insider ownership is 2.64% and the float percentage of total shares outstanding 96.80%.

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