FINANCIAL REPORT

Prepared for: Professor Hong Dong

Prepared by: David Bin Wern Cheng
Hong Yi Joel
Lau Yue Chwen
Lim Ching Ee
Tay Pin
 Starbucks Fundamentals 1

- Introduction 1
- Porter’s Five Forces 1
- Risks Faced by Starbucks 1
Competitor Comparison 2

- Share Price Comparison 2

- Reasons for the Outperformance 2
Partnership with Tingyi Holding Corp 4

- Potential Effect on Future Performance 4

- Stock Price Relation 5
Financial Ratio Analysis 6

- Profitability 6
- Liquidity Ratios 6
- Leverage Ratios 6
- Turnover Ratios 7
- ROA and ROE 7
- Market Value 8
Risk-Reward Analysis 8
CONTENTS

- Beta Analysis 8
- Time Comparison 8
- Cost of Equity 9
- Cost of Debt 9
- Weighted Average Cost of Capital 10
Investment Opportunity 10

Conclusion 10

Appendix
STARBUCKS’ FUNDAMENTALS
Introduction
Starbucks is a premium retailer of specialty coffee globally, operating in more than 60 countries worldwide. Operating
in the specialty food industry, Starbucks is a dominant player with a large consumer-base with competitors such as
Dunkin’ Brands and McDonald’s. Starbucks’ main operating revenue comes from sales in company-operated stores,
with an emphasis on consumer experience through The Starbucks Experience of superior customer service and
targeted rewards program.

Porter’s Five Forces

Customer's Bargaining Power

5 Force Rating
4
3
Competitive rivalry Strong
2 Customers’ Bargaining
Threat of New Entrants Competitive Rivalry Strong
1 power
0
Suppliers’ Bargaining
Moderate
power
Threat of substitutes Strong
Threat of Substitutes Suppliers Bargaining power Threat of new
Moderate
Source: Team’s Assessment
entrants

Using the Porter 5 forces framework, we find that Starbucks faces strong competition and strong threats of substitutes
due to the relatively low barriers of entry into the specialty coffee industry and other potential caffeine product
substitutes. This also results in strong customer bargaining power as customers can easily switch to other coffee joints
if they dislike the quality of Starbucks coffee. However, Starbucks only experiences a moderate threat of new entrants
as it enjoys an established brand with a strong customer base. This is a result of its strong rewards program that helps
to promote brand loyalty. With regards to supplies, Starbucks has taken steps to diversify its supply chain with several
suppliers as well as diversifying its core business to include other savoury products and new beverage options like tea
resulting in only a moderate threat from suppliers.

Please refer to Appendix A for a detailed Porter 5 forces analysis of Starbucks.

Risk faced by Starbucks

Starbucks’ core business of coffee depends on their
purchase, roasting, and sale of high-quality Arabica
coffee beans and coffee products. However, being an
expensive and valued commodity, the price of coffee
faces significant volatility and potential price increases.

Coffee Prices are susceptible to supply shocks due to

events such as natural disasters, poor harvests and
inventory levels often led to unexpected price increases.
Coffee prices doubled in 2014 due to droughts in Brazil.

In 2014, droughts in Brazil resulted in poor harvests and severely disrupted supplies of coffee beans resulting in the
doubling of coffee prices. These price hikes present a risk to Starbucks and threatens their profitability. However,
Starbucks aims to reduce such risks through fixed-price purchase commitments. Starbucks have also taken appropriate
measures to mitigate such risks, such as the diversification of its core business and supply chain.

1
Competitor Analysis
Share price comparison

Starbucks competes in the retail coffee industry

with two of its closest competitors Dunkin’ Brands
(DNKN) and McDonald’s (MCD). Dunkin’ Brands
owns and operates Dunkin’ donuts whose coffee
sales accounts for 60% of its sales. McDonald’s
competes in the retail coffee industry with its
McCafe stores which serves flavored and premium
coffees. These three companies are also
competitors in the sale of coffee beans in their
retail stores.

In a 3-year analysis of Starbucks’ stock price percentage change as compared to its competitors, it is evident that
Starbucks has outperformed them. Since the last quarter of 2014, Starbucks have been able to sustain a consistently
higher percentage change in stock price than its competitors.

Reasons for the outperformance

Starbucks’ Innovation led to increase in revenue

Starbuck’s introduction of mobile payment technology provided a

competitive advantage over its competitors. The Order-and-Pay feature
allows customers to make prior purchases and payment online while
collecting their drinks after, effectively reducing time spent waiting in
queues in the stores. The reduced waiting time allows for an increase in
efficiency. This leads to a boost in in-store sales, which is Starbuck’s main
revenue driver.

Starbuck’s Mobile Order-and-Pay App,

launched December 2015

Starbuck’s My Rewards Program, launched December 2009

Furthermore, Starbucks’ My Starbucks Reward program, which is tied in with their mobile payment application,
encourages more brand loyalty by allowing customers to earn and redeem drinks. This encourages loyalty and makes
it more difficult for competitors to entice customers to switch over to their products. Hence, competitors will have to
offer more value in terms of discounts etc. to convince Starbuck’s customers to forgo their reward points.
2
Focus on expansion into China and the Asia Pacific
Starbucks Store Counts With increasing sales growth and stores sales in China and
4,000 the Asia Pacific (CAP), Starbucks has identified this region
3,000 as a growing market that can be tapped into. Thus, it has
2,000 placed an increased focus on the China and Asia Pacific
1,000 market as a strong driver for growth.
-
2013 2014 2015 2016 In 2015, the consolidation of Starbucks Japan led to a 112%
China CAP increase in segment revenue, as well as the opening of 767
Source: Starbucks Supplementary Financial Data - Store new stores that contributed to a 9% increase in comparable
Counts (By Country) store sales. Furthermore, Starbucks has planned half of
Total CAP Revenue ('000,000) their net new store openings in the future within the
China/Asia Pacific segment.
3,000
2,000 Besides the opening of new stores, Starbucks’ pivot
1,000 towards the Chinese market is also evident in its new
-
ventures targeted towards Chinese consumers.
FY 09 FY 10 FY 11 FY 12 FY 13 FY 14 FY 15 FY16

Source: Starbucks Supplementary Financial Data –

Historical Revenue Summary

Renewed and expanded product offerings

Besides its focus on coffee, Starbucks has also looked towards tea - the favoured
drink of choice of Chinese consumers – as a two-pronged strategy to cater to
their tastes. With its strong tea culture and history, Starbucks has targeted the
retail industry of specialty teas through the Teavana brand as a strategy to boost
sales. This comes as the tea market in China is much larger and provides more
opportunities as compared to coffee.

To distinguish itself from other companies, Starbucks’ Teavana brand aims to

target the more expensive market segment with more upscale tea blends,
building in tandem with its specialty coffees. The move towards tea also serves
as a means for Starbucks to diversify its core business of coffee which will
provide a hedge against potential price volatility in coffee beans.

Starbuck’s competitors are undercutting each other rather than Starbucks

MCD on DNKN SBUX on MCD SBUX on DNKN

Beta -.034 0.61 0.14

Starbuck’s returns are positively correlated to its two closest competitors, Dunkin’ Brands Group and McDonald’s, at
a regression value of 0.14 and 0.61 respectively. However, the returns of these two competitors are inversely related
at a regression value of -0.34. This suggests that while Starbucks share similar systemic risks to that of its competitors
due to them being in the same industry, McDonald’s and Dunkin’ Brands’ sales growth tend to undercut each other
more than Starbucks.

One possible reason is the fact that Starbucks’ products target the more affluent sector of consumers while Dunkin’
Brands and McDonald’s both target middle-income consumers. Thus, the product offerings of Starbucks’ two
competitors are closer substitutes as compared to Starbucks, hence they have a reduced impact on Starbucks’ sales.

3
Partnership with Tingyi Holding Corp

On March 18, 2015, Starbucks and Chinese leading food and

beverage producer Tingyi Holding Corp “Tingyi” announced
that they have entered an agreement to manufacture and
expand the distribution of Starbucks ready-to-drink (RTD)
products throughout mainland China. Starbucks will assume
responsibility in areas such as coffee expertise, brand
development, innovation, while Tingyi will oversee the local
Chinese market through manufacturing and managing the
TINGYI (CAYMAN ISLANDS) HOLDING CORP.
Starbucks RTD portfolio in China.

Potential Effect on Future Performance

The agreement to expand into China’s huge Ready-To-Drink (RTD) Coffee Market is highly strategic to Starbuck’s
expansion plans. The RTD coffee and energy category is a $6B business, and is projected to grow by over 20% in the
next 3 years.

Tingyi Holding Corp is the largest instant noodle producer in

Tingyi Market Share in Beverage Sector
China, and specialises in the production and distribution of
instant noodles, beverages, baked goods and soft drinks
RTD Tea 55.4% under its brand name: Master Kong. Tingyi possesses a very
strong presence in China’s beverage sectors. It holds the
Bottled Water 17.6% second largest market share in the Bottled water market as
well as the carbonated drinks market.

Bottled Juice
Carbonated Drinks
(Exclusive Pepsi Manufacturer)
Source: MarketLine Advantage
20% In the Ready-to-drink (RTD) Tea segment, Tingyi commands
the largest market share of 55.4%. With the partnership,
28.8% Starbucks will be able to leverage on Tingyi’s access to the
RTD Tea market to promote its tea products.

With Starbuck’s traditional coffee products, Tingyi’s expertise and presence in the Food & Beverage market in China
will offer Starbucks a valuable inroad in reaching out to Chinese consumers, and increase its market share in the China.

Furthermore, with the agreement in place, Starbucks will be able to produce their RTD coffee in large quantities by
leveraging on Tingyi’s 132 production centres and 711 production lines. Therefore, the team can expect Starbucks to
reap significant cost savings due to economies of scale through large production quantities. They will also be able to
pass on some cost savings to their consumers in the form of more competitive prices.

4
Stock Price Relations

Analysing the stock price, Starbucks’ stock price had been on uptrend before the agreement with Tingyi was announced.
After the announcement of the news of the agreement, there was a significant increase in the volume of shares traded
over the period of 3 days. This contributed to the uptrend in share price as investors priced in their expectations of
future growth from Starbucks’ investment towards their main source of future growth – China. Starbucks has since
enjoyed considerable success in the Chinese market, by leveraging on the growing preference for premium coffee
amongst the Chinese population. This is reflected in the consistent steady uptrend in SBUX share price following the
announcement.

March 18 2015:
Partnership Announcement

Significant increase in volume of shares traded after partnership with Tingyi

Holding Corp. is announced.

The only inconsistency in our evaluation of the SBUX share

price within the period is the sharp fall in late August 2015.
Doing future analysis, it is evident that this fall in share
price was seen in Starbucks, Dunkin’ Brands and
McDonald’s. Furthermore, it could also be seen that this fall
in share price was an industry wide fall when pegged to the
performance of the S&P500, which also fell in the same
period.

Late august 2015: Consistent drop in share-price percentage change across industry

Overall, the consistent uptrend in share price is in line with news announcements reflecting the strong intention of
Starbucks to break into the Chinese market, with Starbucks CEO and Chairman, Howard Schultz claiming that he
remains confident about the company’s performance in the country and plans to almost double Starbucks stores in
China to 5000. Starbucks has plans to increase its brand prominence by pushing the Teavana brand in its overseas
stores, providing them an additional edge in the Chinese market with its preference for tea.

Starbucks’ already strong brand as a premium coffee, coupled with the increased production capabilities and strategic
information provided by Tingyi will serve to make Starbucks a competitive brand in the RTD coffee market in China.
Viewing the long-term trend, it can be expected that the share price will continue in a general uptrend in the future as
Starbucks expands its business in China.

5
Financial Ratio Analysis
Profitability Liquidity ratios

FY2015 FY2014 FY2013 FY2012 FY2015 FY2014 FY2013 FY2012

Gross Current
59.4% 58.3% 57.1% 56.2% 1.09 1.37 1.02 1.90
Margin Ratio
Operating Quick
20.5% 18.7% (1.4%) 15.0% 0.73 1.01 0.81 1.34
Margin Ratio
Net
14.4% 12.6% 0.1% 10.4%
Margin As of Dunkin’ Industry
Starbucks McDonald’s
FY2015 Brands Average
Horizontal analysis shows that Starbucks has Current
experienced strong profitability margins that increase 1.09 1.33 3.27 0.91
Ratio
steadily each year. Although the operating margin and Quick
net margin suffered a fall in FY2013 due to a litigation 0.73 - 3.23 0.74
Ratio
charge of $2.8 billion to Kraft Foods, Starbucks
recovered quickly in FY2014 as the gross margin, Starbucks’ liquidity has decreased in FY2015 as the
operating margin and net margin were higher than the current ratio and quick ratio both fell from (1.37; 1.01)
years before. This shows that Starbucks is efficient in to (1.09; 0.73). The current ratio and quick ratio are
generating profits from sales. also lower than the peers and industry average. This
could be attributed to Starbucks’ active use of its cash
As of Dunkin’ Industry resources to invest in core businesses, return cash to
Starbucks McDonald’s
FY2015 Brands Average
shareholders through common stock cash dividend
Gross payments and share repurchases, as well as other new
59.4% 83.8% 38.5% 48.0%
Margin business opportunities. Hence, this has resulted in a
Operating decrease in current assets.
20.5% 36.9% 28.1% 13.3%
Margin
Net Leverage ratios
14.4% 13.0% 17.8% 6.6%
Margin
FY2015 FY2014 FY2013 FY2012
Overall, Starbucks is performing relatively well in
Debt-to-
comprison with its peers. The company’s gross margin,
Equity 0.40 0.39 0.29 0.11
operating margin, and net margin are higher than the
Ratio
industry average (48%; 20.5%; 14.4%), signalling that
Interest
Starbucks has healthy profitability margins. 47.5 43.6 78.6 54.6
Coverage
Starbucks’ margins are expected to increase in the
Starbucks has low financial leverage as observed from
coming years due to the numerous strategy growth
its low debt to equity ratio and high interest coverage
plans that Starbucks is implementing. The company has
ratio. The company currently has a low debt to equity
employed digital initiatives such as a new mobile
ratio of 0.4. A low debt to equity ratio signals that the
loyalty program and digital payment platform to
amount of Starbucks’ capital funded by debt is much
increase its customers’ loyalty. This is expected to
lower than by equity. Thus, Starbucks is highly able to
generate higher profits due to an increase in revenue
satisfy its debt obligations and has low financial risk.
and better operating efficiency due to the reduction in
Starbucks also has significantly high interest coverage
labour time and costs to process physical payment.
ratio (47.5). This means that Starbucks has sufficient
Therefore, Starbucks has an optimistic outlook for its
earnings to cover its the interest payment to the
profitability margins.
creditors. Moreover, it also means that Starbucks
could take on more borrowing without taking
excessive insolvency risk.

6
 As of FY2015 Starbucks
Dunkin’
McDonald’s
Industry assets efficiently and generate high profits from its
Brands Average assets.
Debt-to-
Equity 0.40 - 3.40 0.75 As of Dunkin’ Industry
Starbucks McDonald’s
Ratio FY2015 Brands Average
Interest ROA 23.8% 3.8% 13.9% 11.0%
47.5 3.70 11.5 4.7
Coverage ROE 49.7% - 45.4% 13.0%

Starbucks has lower debt-to-equity than its peers and
industry average as well (McDonald’s: 3.40; Industry
Average: 0.75). Hence, due to its low financial risks,
Starbucks is an ideal and safe investment for the
investors.
Turnover Ratios
Starbucks has a high ROE (49.7%) which shows that
Starbucks is efficient in using shareholder’s funds to
produce profits. Moreover, Starbucks’ ROE
outperforms its major competitor, McDonald’s (45.4%)
and the industry average (13%). Below is the detailed
breakdown of Starbucks’ ROE using the Du Pont
Identity Analysis:

FY2015 FY2014 FY2013 FY2012 ROE = Profit Margin (PM)* （Total Asset Turnover
Inventory (TAT) – Interest Rate Expense)* Equity Multiplier
6.50 6.20 5.40 5.30
Turnover (EM) * Tax Retention Rate

Dunkin’ Industry
Starbucks McDonald’s
Brands Average Starbucks’ profit margin stands at 14.4% which is
higher than the industry average (6.6%). This means
Inventory
Turnover 6.50 - 148.7 41.7 that Starbucks has high operating efficiency in
controlling its costs. Therefore, this has translated into
a higher ROE for the investors.
Using horizontal analysis on Starbucks’ turnover ratios
in the past four years, the team understands that it has The company also has a higher TAT (1.65) than the
increasing steadily over the year. Inventory turnover is competitors (Dunkin’ Brands: 0.69; McDonald’s: 0.70)
an important ratio in the food and beverages industry and industry average (0.69). This indicates that
as investors are eager to know the rate at which the Starbucks is efficient in managing its assets to
perishable inventory is sold over a time. Therefore, it is generate sales revenue and this has in return,
a positive note that Starbucks has an improving increased the ROE.
turnover ratios over the years. However, its turnover
ratio still lags its peers and competitors (McDonald’s: As of FY 2015, Starbucks has an interest rate expense
148.7; Industry average: 41.7) and thus, Starbucks of 0.57%. This is significantly lower than its
should seek to continue improving its turnover ratio in competitors (Dunkin’ Brands: 3.03%; McDonald’s:
the future. 1.68%). Based on the low interest expense rate, we
could infer that Starbucks is a relatively safe company
ROA and ROE as creditors are willing to charge Starbucks a lower
interest rate compared with its peers which might be
FY2015 FY2014 FY2013 FY2012 deemed more risky than Starbucks. Therefore, this
Return on could attribute to Starbucks’ high ROE.
Assets 23.8% 18.6% 0.08% 17.8%
(ROA) Starbucks has an EM that is lower than McDonald’s
Return on (4.4) and the industry average (1.75). This is because
Equity 49.7% 42.4% 0.2% 29.2% Starbucks has a low debt to equity ratio due to the low
(ROE) financial leverage. Although this affects Starbucks’
ROE, a lower financial leverage would also mean lower
Starbucks’ ROA currently stands at 23.8%, which is risks for the stockholders, which is a desirable financial
higher than the competitors (Dunkin’ Brands: 3.82%, situation.
McDonald’s: 13.9%) and industry average (11%). This
high ROA signals that Starbucks is able to manage its Starbucks’ effective tax rate of FY 2015 currently
stands at 29.3%, which is also lower than the

7
competitors (Dunkin’ Brands: 40%; McDonald’s: As seen from the beta analysis above, all 3 companies
30.9%). As Starbucks enjoys low corporate tax, this has have a market beta which is less than 1, reflecting that
helped Starbucks to generate a higher ROE for its their share prices have less volatility than the market.
investors in comparison with its peers. This is due to the nature of the food industry where
demand for necessities tend to be more stable
Therefore, coupled with (i) strong operating efficiency, regardless of economic swings. However, of all the 3
(ii) good asset use efficiency, (iii) low financial companies, Starbucks has the highest market beta,
leverage, (iv) low interest rate expense and (v) low while Dunkin’ Brands has the lowest market beta.
corporate income tax, Starbucks evidently
outperformed its competitors with its high ROE One potential reason for this is that Starbucks tends to
offer premium and higher priced products as compared
Market Value to Dunkin’ Brands. A cup of coffee at Starbucks has an
average cost of $6 while a cup of coffee at Dunkin’
As of Dunkin’ Industry Brands costs $3. This difference in price will is due to a
Starbucks McDonald’s different in the consumer segment that both brand are
FY2015 Brands Average
P/E 33.0 39.10 24.64 28.96 targeting. Dunkin’ Brands aims to capture the lower-
P/B 15.3 - 15.11 4.13 middle consumers whereas Starbucks aims to target
the middle-upper class segment. This difference will
FY2015 FY2014 FY2013 FY2012 also result in Dunkin’ Brand being more resilient to
P/E 33.0 30.3 10,000 28.8 market volatility as a cheaper-priced product will be
P/B 15.3 11.7 13.2 7.8 more demand inelastic due to the reduced purchasing
power required.
Starbucks has a high P/E (33.0) and P/B (15.3) that
outperforms its peers and industry. Due to its nature as Despite Starbucks a more premium brand, its stock
a stable company, it is believed that there is strong price has a beta value of less than one due to its loyalty
market confidence in the company’s future growth. program schemes and business model. To date, there
This could be attributed to Starbucks’ further are about 19 million individuals who have downloaded
expansion plans into the China market as well as the the Starbucks mobile app and this accounts for about
tea industry through its tea brand – Teavana - which eight million orders per month through this revenue
could be a profit generating opportunity for the channel. This app has increased convenience and
company. Moreover, analysis of Starbucks’ impressive efficiency in the purchase of its products. Apart from
profit margins and low financial leverage signals that convenience, Starbucks’ loyalty rewards program has
the stock price could still increase as the company has succeeded in tandem with its mobile app. In the
great growth potential in the future. previous quarter, there were approximately 900,000

new signs up for the rewards program and as of March

Risk-Reward Analysis 31, there were 12 million members in the United States.
This loyalty program is a reason why Starbucks is
Beta Analysis preferred over its competitors, leading to demand for
SBUX MCD DNKN SBUX Starbucks’ products to be more inelastic. This reduces
the risk of reduced sales during a period of poor
5-year 5-year 5-year 3-year
Market
economic growth, as Starbucks customers will
Beta 0.83 0.61 0.24 0.70 continue to purchase its products.

In general, companies in the food and services industry Time comparison

are less likely to be affected by market volatility as food
is deemed as a necessity, and thus it is more demand
inelastic.
Peer comparison
Based on our calculations, Starbucks has a 5-year
market beta of 0.83. Compared to Starbucks’
competitors, McDonald’s has a market beta of 0.61
while Dunkin’ Brands has a market beta of 0.24.
In comparing Starbucks’ 3-year beta to its 5-year beta,
there is a decrease from 0.83 to 0.7, indicating that
Starbucks share price has become less volatile in recent
years. This could be explained by the Starbucks’ recent
developments. In particular, this is through its loyalty
programme. As explained above, Starbucks has placed
increased focus on its loyalty programme in recent
years reducing its exposure to market volatility.

8
Cost of Debt
Starbucks McDonald’s Dunkin’ Brands
Cost of
2.022 2.898 3.957
Debt
Starbucks has the lowest cost of debt among the
competitors. This is as Starbuck holds the least amount
of corporate bonds and long-term debt. In addition, the
ratings of Starbucks’ debt are AAA while most of
McDonald’s debt are rated B, showing that Starbucks
takes on less risky debt. Moreover, the Yield to
Maturity (YTM) of Starbucks’ bonds is relatively low
resulting in its cost of debt being lower than its
competitors. However, there is a possibility that the
cost of debt of Starbucks may increase in the future
due to the company’s expansion into Asia, thus leading
to a need to raise more capital through debt.
In general, it is fair to expect that Starbuck’s has the
highest WACC among the competitors. Starbucks’
WACC is the highest since it has the largest cost of
equity, although the cost of debt for all 3 companies
are low. Conversely, Dunkin’ Brands has the lowest
WACC as it has the lowest cost of equity. Hence,
investors expect a higher return from Starbucks as
compared to its competitors. This has been the case as
seen by the share prices of the company, with
Starbucks having the highest increase in share price in
recent years. Also, Starbucks’ WACC is the highest
among its competitors due to the increased level of risk
it is taking from its geographic and product expansion.
Nonetheless, its risk is justified by its revenue, with its
share prices reaping strong rewards.

Cost of Equity

Dunkin’
Starbucks McDonald’s
Brands
Cost of
8.48 7.16 4.94
Equity

Cost of equity is the return that stockholders requires

for a company to compensate for the risk they are
undertaking. Starbucks’ cost of equity is the highest
among the competitors, which is consistent with the
beta value due to its increased exposure to systematic
risk. One possible reason is that Starbucks has the
highest cost of equity due to its recent expansion.
However, in the long run, this expansion strategy will
likely generate higher revenue and returns for the
shareholders.

The cost of equity can be used as a discount rate to

estimate a stock or investment’s fair value, as investors
expect their investments to grow at a rate equal or
greater than the cost of equity.

Weighted Average Cost of Capital (WACC)

Starbucks McDonald’s Dunkin’ Brands

Oct
8.19 6.43 3.93
2016

The WACC seeks to calculate and quantitatively analyse

the market’s perception of a company's assets based
on the the riskiness of equity and debt which has been
elaborated in the sections above.

9
Potential Investment Opportunity
With Starbucks’ strong core business and positive future outlook, it can be explored as a potential investment
opportunity. Starbucks’ cash dividend records show a consistent quarterly pay-out to its shareholders since they first
began issuing dividends in 2010, representing a history of returning cash back to its shareholders. The firm has steadily
increased their yearly dividend per share, including increases of 23.08% and 23.81% in the last two years. As such, the
dividend discount model (DDM) can be an appropriate model to value Starbucks.

We assume Starbucks’ dividend growth rate will grow initially at 25.24% for 5 years, which is the average yearly
increase over the last five years. The growth rate will then linearly decrease for the next 5 years until it reaches a stable
growth rate of 3.5%. This growth rate is derived from the market premium.

Required Rate of Return – The required rate of return is based on the calculated cost of equity of 8.48%, as discussed
in the WACC section above.

Based on the following assumptions, the DDM shows an intrinsic value of $56.11. Starbucks’ share price as of 5th
November 2016 is $52.75, thus showing that Starbucks is currently undervalued, which can be a potential investment
opportunity, backed its strong growth prospects.

Conclusion
Considering Starbuck’s strong expansion strategy in both its geographical presence and product line, it is evident that
Starbuck’s has strong growth prospects. This is further supported by financial ratio analysis where it is noted that
Starbucks has strong core margins, low debt exposure, a healthy operating efficiency and outstanding returns on
equity and assets.

In addition, Starbucks faces low systematic risk as seen from its beta. This is primarily due to the foods and services
industry it is in, the nature of its product offerings coupled with loyalty programmes, rendering its goods and services
as relatively demand inelastic.

With the discount dividend valuation indicating that Starbucks stocks are currently undervalued, Starbucks can be a
potentially profitable investment

10
APPENDIX

Appendix A: Starbucks Potter’s 5 Analysis

Force Rating Analysis
 Starbucks faces competition from other industry players e.g. McDonald’s
Competitive  Low barrier of entry into the specialty coffee industry
Strong
rivalry  Low switching costs as consumers can easily switch brands although
Starbucks’ successful rewards program helps to build a loyal customer base
 With store sales being a main source of revenue for Starbucks, its success
Customers’ depends largely on the satisfaction of customers
Bargaining Strong  Being a premium brand, cost-conscious customers can switch to other
power cheaper brands should they desire
 The availability of other competitors provides alternatives for customers
 Starbucks’ specialty coffee depends on its supply of premium coffee beans
Suppliers’ from suppliers
Bargaining Moderate  Price of coffee beans may be volatile due various factors
power  However, Starbucks has taken steps to diversify its supply chain with
several suppliers as well as diversifying its core business
 Strong force due to many potential substitutes and competitors in the
Threat of
Strong coffee industry
substitutes
 Low switching costs
 Low barrier of entry for competitors
 Starbucks has an established brand with a strong customer base
Threat of new  Strong rewards program helps to bring about returning customers and
Moderate brand loyalty
entrants
 Cost of supply chain of coffee beans provides a deterrent to new industry
competitors

I
Appendix B: 5-year monthly returns of S&P 500, Starbucks and Competitors

Monthly 5-year Data

Date S&P 500 Last Close SBUX last close MCD last close DNKN last close S&P 500 Returns SBUX Returns MCD Returns DNKN Returns
01/09/2016 2159.929932 54.189999 116.879997 50.310001 -0.5076% -3.6280% 1.0548% 2.7783%
01/08/2016 2170.949951 56.23 115.660004 48.950001 -0.1219% -2.7979% -0.9274% 8.7261%
01/07/2016 2173.600098 57.848541 116.742729 45.021404 3.5610% 1.6282% -2.2353% 3.8744%
01/06/2016 2098.860107 56.921768 119.41198 43.342167 0.0911% 4.0627% -0.6844% 0.7623%
02/05/2016 2096.949951 54.699509 120.234924 43.014271 1.5325% -2.0415% -3.5023% -6.2648%
01/04/2016 2065.300049 55.839478 124.598686 45.889153 0.2699% -5.8124% 0.6445% -1.4204%
01/03/2016 2059.73999 59.285381 123.800804 46.55035 6.5991% 2.5597% 7.2446% 1.9144%
01/02/2016 1932.22998 57.805725 115.437752 45.675934 -0.4128% -3.8996% -4.6067% 18.3435%
04/01/2016 1940.23999 60.151375 121.012451 38.596066 -5.0735% 1.2327% 4.7740% -7.5839%
01/12/2015 2043.939941 59.418907 115.498558 41.763374 -1.7530% -2.2153% 3.4863% 0.4008%
02/11/2015 2080.409912 60.765064 111.607544 41.596672 0.0505% -1.5682% 2.4990% 3.1040%
01/10/2015 2079.360107 61.733173 108.886497 40.344395 8.2983% 10.0809% 13.9247% -15.4898%
01/09/2015 1920.030029 56.079807 95.577606 47.739082 -2.6443% 3.8933% 3.6940% -2.3126%
03/08/2015 1972.180054 53.978294 92.172783 48.869232 -6.2581% -5.2980% -4.0085% -6.4358%
01/07/2015 2103.840088 56.998074 96.021797 52.230701 1.9742% 8.0380% 5.0384% -2.0182%
01/06/2015 2063.110107 52.757408 91.415901 53.306526 -2.1012% 3.1948% -0.8965% 3.5936%
01/05/2015 2107.389893 51.124111 92.242844 51.457359 1.0491% 5.1337% 0.2213% 2.3988%
01/04/2015 2085.51001 48.627693 92.039169 50.25193 0.8521% 4.7096% -0.9134% 9.5669%
02/03/2015 2067.889893 46.440521 92.887589 45.86417 -1.7396% 1.2943% -1.4762% 2.0896%
02/02/2015 2104.5 45.847141 94.279373 44.925419 5.4893% 7.1989% 7.9181% -0.9512%
02/01/2015 1994.98999 42.768276 87.361984 45.356838 -3.1041% 6.6789% -1.3447% 10.9261%
01/12/2014 2058.899902 40.090679 88.552765 40.889225 -0.4189% 1.0344% -3.2125% -11.7890%
03/11/2014 2067.560059 39.680244 91.49192 46.353901 2.4534% 7.9215% 4.1991% 6.8329%
01/10/2014 2018.050049 36.767704 87.804893 43.389153 2.3201% 0.1325% -1.1391% 1.4726%
02/09/2014 1972.290039 36.719044 88.816612 42.759495 -1.5514% -3.0202% 1.1630% 2.9398%
01/08/2014 2003.369995 37.86256 87.795525 41.538342 3.7655% 0.5044% -0.0328% 2.1127%
01/07/2014 1930.670044 37.672543 87.824348 40.678925 -1.5080% 0.3877% -6.1346% -6.4396%
02/06/2014 1960.22998 37.52705 93.56414 43.478806 1.9058% 5.6527% -0.6803% 2.3459%
01/05/2014 1923.569946 35.519268 94.204994 42.482235 2.1030% 4.0916% 0.8558% -1.1352%
01/04/2014 1883.949951 34.123089 93.405647 42.970013 0.6201% -3.7612% 3.4173% -9.3065%
03/03/2014 1872.339966 35.456699 90.319153 47.379375 0.6932% 3.4104% 3.0268% -2.4472%
03/02/2014 1859.449951 34.287373 87.665695 48.567909 4.3117% 0.1526% 1.9015% 11.0466%
02/01/2014 1782.589966 34.235138 86.029877 43.7365 -3.5583% -9.2741% -2.9475% -3.4647%
02/12/2013 1848.359985 37.734707 88.642654 45.30624 2.3563% -3.7687% -0.3492% -1.5925%
01/11/2013 1805.810059 39.212521 88.95327 46.03941 2.8049% 0.8296% 1.7197% 3.1348%
01/10/2013 1756.540039 38.889908 87.449417 44.640018 4.4596% 5.3008% 0.3222% 5.3469%
03/09/2013 1681.550049 36.932217 87.168549 42.37431 2.9750% 9.1463% 1.9606% 5.0360%
01/08/2013 1632.969971 33.837337 85.492409 40.342667 -3.1298% -0.7985% -3.0156% 0.1855%
01/07/2013 1685.72998 34.109692 88.150658 40.267975 4.9462% 8.8231% -0.9293% 0.8874%
03/06/2013 1606.280029 31.344172 88.977516 39.913765 -1.4999% 3.7536% 2.5163% 8.1313%
01/05/2013 1630.73999 30.210211 86.793526 36.912308 2.0763% 4.1304% -4.7125% 2.5108%
01/04/2013 1597.569946 29.011904 91.085999 36.008202 1.8086% 6.8306% 2.4576% 5.2332%
01/03/2013 1569.189941 27.156935 88.901146 34.217533 3.5988% 3.8286% 3.9520% -0.6465%
01/02/2013 1514.680054 26.155537 85.521317 34.440205 1.1061% -1.8957% 1.4520% 2.2041%
02/01/2013 1498.109985 26.660952 84.297302 33.697475 5.0428% 4.6429% 8.0263% 10.0362%
03/12/2012 1426.189941 25.478027 78.03405 30.624001 0.7068% 3.3931% 1.3442% 4.2740%
01/11/2012 1416.180054 24.641903 76.999023 29.368767 0.2847% 13.4767% 1.1769% 3.1442%
01/10/2012 1412.160034 21.715378 76.103333 28.473492 -1.9789% -9.4853% -5.3951% 6.1644%
04/09/2012 1440.670044 23.990995 80.443329 26.820192 2.4236% 2.2173% 2.5254% 0.2403%
01/08/2012 1406.579956 23.470585 78.46183 26.755896 1.9763% 9.9885% 0.9336% -3.3091%
02/07/2012 1379.319946 21.339117 77.736107 27.671564 1.2598% -15.0788% 0.9375% -11.8229%
01/06/2012 1362.160034 25.12813 77.014069 31.381821 3.9555% -2.8603% -0.9066% 5.7592%
01/05/2012 1310.329956 25.868025 77.718704 29.672911 -6.2651% -4.0292% -7.6045% 0.7702%
02/04/2012 1397.910034 26.954048 84.115211 29.446117 -0.7497% 2.6481% -0.6626% 7.6130%
01/03/2012 1408.469971 26.258701 84.67627 27.362967 3.1332% 15.0947% -1.1886% 4.0683%
01/02/2012 1365.680054 22.814861 85.694801 26.293272 4.0589% 1.6933% 0.9362% 5.0271%
03/01/2012 1312.410034 22.434961 84.899948 25.034742 4.3583% 4.1513% -1.2758% 10.6885%
01/12/2011 1257.599976 21.540747 85.997093 22.617283 0.8533% 5.8188% 5.0356% -1.2648%
01/11/2011 1246.959961 20.356262 81.874229 22.907015 -0.5059% 3.0454% 3.6494% -13.0883%
03/10/2011 1253.300049 19.754652 78.991493 26.356649 10.7723% 13.5961% 5.7276% 5.0902%
01/09/2011 1131.420044 17.390249 74.712257 25.080015

II
Appendix C: BETA Calculations

SBUX Beta Calculation y = 0.8294x + 0.0113

R² = 0.2207
SBUX Returns 20.0000%

15.0000%

10.0000%

5.0000%

0.0000%
-10.0000% -5.0000% 0.0000% 5.0000% 10.0000% 15.0000%
-5.0000%

-10.0000%

-15.0000%

-20.0000%
S&P 500 returns

y = 0.6078x + 0.0013
MCD Beta Calculations R² = 0.2731
20.0000%

15.0000%

10.0000%
MCD Returns

5.0000%

0.0000%
-10.0000% -5.0000% 0.0000% 5.0000% 10.0000% 15.0000%
-5.0000%

-10.0000%
S&P 500 Returns

y = 0.2342x + 0.011
DNKN Beta Calculations R² = 0.0141
25.0000%
DNKN Returns

20.0000%
15.0000%
10.0000%
5.0000%
0.0000%
-10.0000% -5.0000%-5.0000%
0.0000% 5.0000% 10.0000% 15.0000%
-10.0000%
-15.0000%
-20.0000%
S&P 500 Returns

III
Appendix D: WACC Calculation

Starbucks Dunkin' Brands Group

Regressional beta 0.83 Regressional beta 0.25

WACC Calculation WACC Calculation

Debt (in Mil) 3,350 Debt (in Mil) 2,445.600
Equity (Market Cap in Mil) 78468.6 Equity (Market Cap in Mil) 4,543.882
Debt+Equity (V) 81,819 Debt+Equity (V) 6,989

Cost of debt 2.0223881 Cost of debt 3.9566977

Cost of equity 8.48 Cost of equity 4.94
Effective tax rate 29.3% Effective tax rate 47.8%
Cost of Debt*(1-Tax%) 1.429765661 Cost of Debt *(1-Tax%) 2.065396222

Debt/V 0.040944235 Debt/V 0.349897164

Equity/V 0.959055765 Equity/V 0.650102836

WACC 8.191333547 WACC 3.93418429

McDonald's

Regressional beta 0.61

WACC Calculation
Debt (in Mil) 16,100
Equity (Market Cap in Mil) 97,155.04
Debt+Equity (V) 113,255

Cost of debt 2.8976739

Cost of equity 7.16
Effective tax rate 30.9%
Cost of Debt*(1-Tax%) 2.002292674

Debt/V 0.142157034
Equity/V 0.857842966

WACC 6.426795624

IV
Appendix E: Dividend Discount Model

Starbucks, dividends per share (DPS) forecast

Year DPS Dividend Growth Rate

2011 0.26
2012 0.34 0.307692308
2013 0.42 0.235294118
2014 0.52 0.238095238
2015 0.64 0.230769231
2016 0.8 0.25
Average = 0.2524
Assume constant growth for next 3 years PV of DPS
2017 F 1.00192 0.2524 0.92359882
2018 F 1.254805 0.2524 1.066293476
2019 F 1.571517 0.2524 1.231034245
2020 F 1.968168 0.2524 1.42122722
2021 F 2.464934 0.2524 1.640804729
Assume dividend growth to decline linearly to 3.5% in next 5 years
2022F 2.979908 0.20892 1.828541347
2023 F 3.472904 0.16544 1.964468314
2024 F 3.896459 0.12196 2.031761495
2025 F 4.202253 0.07848 2.019924537
2026 F 4.349332 0.035 1.9271957

Terminal Value of Dividends 90.39275 40.05316365

Implied share price (USD) 56.10801353