Steve Castellano Ascendere Associates LLCsteve@ascenderellc.com Page 2more than 3x to $762m from $211m over the same period. Anyway you look at it -- EBIT, adjusted EBITDA, free cash flow --profitability has surged since December 2008 while the amount of capital required to create this profitability has declined. Thishas helped the company generate a ROIC higher than its cost of capital for the first time in several quarters. In addition, this hasput $700m+ in cash on its balance sheet bringing the total to $1.4b cash and short-term investments. In the most recentconference call the company said it expects to conclude work on a distribution strategy for this excess cash in the comingmonths.
Starbucks learned valuable lessons in its domestic market
CEO Harold Schultz
summarized the recent improvements in the company’s January 20, 2010 conference call transcribed by
Seeking Alpha for the fiscal first quarter that ended on 12/27/2009:
This was a very satisfying quarter by any standard and follows three successive quarters of continued improvement in ourbusiness. Our U.S.-company operated stores reached a significant milestone in Q1 as all regions reported positive comp growthand our U.S.-licensed stores also delivered strong results. As in prior quarters, our business this quarter benefited mightily fromcontinued innovation from the success of our company wide efforts to improve customer experience from our continued laserfocus on controlling operating costs and improving operating efficiency and from the impact of decisive actions we took early in2008.
Given the significant operating improvements seen thus far, maybe it is not a surprise the stock has seen a 165% rally from aMarch 2009 low of $8.27 to a recent close of $21.91, outperforming the S&P 500 return of 56% and the S&P Discretionary SPDR(XLY) return of 78% over the same period. If estimates are revised further upward, there could be more room for SBUX to move.
Upside possible if company remains focused and if global economies improve
We find the current consensus estimates that imply continued improvements for ROIC and solid earnings growth believable andperhaps containing some potential to move even higher, which makes us comfortable with not overly-weighting a negativevaluation scenario. The company seems to have learned some valuable lessons in its U.S. market, and has recently startedincreasing marketing spending to drive revenue on some key growth platforms and initiatives. It is also increasing investment inits well-received VIA instant coffee product and on efforts to "refresh" the designs of existing Starbuck stores. In addition, thecompany intends to apply the lessons learned in the U.S. to international markets. For now, international efforts appear to beconcentrated in the U.K., France, Spain and China.Starbucks believes China will become its largest market outside of the U.S. If Starbucks can drive revenue in China and otherinternational locations to one-half to two-thirds of the level of growth experienced in its early growth phase in the United States,there could be significant upside to consensus revenue and earnings growth forecasts.
Relative valuation summary
Starbucks is currently trading at 20.2x NTM consensus EPS of $1.12 versus a 5yr average of 26.8x and a range of 10.1-53.4x.Fifteen sell side analysts provide targets ranging $13 to $30 and average $25. Nineteen sell side analysts provide FY2011 EPSestimates ranging from $1.15 to $1.41 and average $1.25.On a relative EV/EBITDA basis, SBUX trades at a slight discount to a peer average, and on a PE basis it is at a premium. Given itshigh growth prospects and ROIC profile, these multiples are justifiable and actually offer a slightly better adjusted value at thissnapshot in time -- but they do not point to an overwhelming bargain.
We have chosen 4 different scenarios in which to value Starbucks. Numerous underlying factors can be summarized in the long-term earnings growth rates on a 10% WACC and 2.5% terminal growth rate -- 21%, 18%, 8% and negative 3%. A more aggressive9% WACC and 3% terminal growth rate may be justifiable, and could positively impact our range of targets by about $1-10.
The most realistic but conservative assumption in our opinion is the 8% growth scenario, which suggests the stockdeserves to trade at only about 17x the consensus NTM EPS estimate of about $1.12 or at about $19 one year from now.