Why-Starbucks-Remains-My-Top-Pick

Starbucks Corp (SBUX) needs no introduction. No matter where in the world, everyone has witnessed the meteoric rise in the company over the years. But is all the growth behind them and is Starbucks now turning into a slow growing dividend paying company? Not at all! Starbucks was my top pick for 2015 and the stock price appreciated a massive 48.8% and paid an additional 1.2-1.3% in dividends bringing the total return to a neat 50% in 2015. I expect 2016 to be no different and I discuss details in this article to illustrate why Starbucks remains my top pick for 2016.

Even though I wasn’t a shareholder for the whole year, I watched that stock price climb relentlessly and eventually used the mini-correction in August to initiate my position in SBUX. This is going to be the first of my many purchases of this amazing company. The overall stock market may have remained flat over the course of 2015, but some companies have seen stellar returns. Some great performers have been companies like Alphabet Inc (GOOG), Facebook Inc (FB), Netflix Inc (NFLX), Amazon Inc (AMZN), Nike Inc (NKE), Visa Inc (V), JetBlue Airways Corp (JBLU) etc. If we try to understand why these companies performed so well compared to others, they all have a common theme underlying: high revenue growth.

The low interest rate policies set by the U.S. Fed has allowed companies to borrow at record low rates and use the funds for buybacks instead of investing for the long term. While this has worked to keep the earnings propped up, it’s a short term band-aid solution and I remain critical of companies like IBM Corp (IBM), which have merely become financial engineering firms. Note that, I am not suggesting that buybacks are useless or should be completely banished by board of directors, as they play a role in keeping the outstanding share numbers in check. However, the buybacks should not take priority over investing for the company’s long term growth and those funds could’ve been better used elsewhere.

Share buybacks can manipulate the earnings of a company, but revenue cannot be manipulated and this is the reason why companies such as Starbucks, Nike, Netflix, Amazon etc continue to outperform.

Inspiration

One of the books I read in 2015 that inspired me – not just to invest in, but also as a business book was Starbucks Corp CEO Howard Schultz’s book entitled “Pour Your Heart Into It: How Starbucks Built a Company One Cup at a Time”. This is not a new book (originally published in 1999) and it’s been on my reading list for a while now. If you are looking for inspirational reads – I highly recommend it.

For those unaware, Howard Schultz is truly a rags-to-riches story and embodies everything American. He is a self-made man who grew up in the projects in Brooklyn, NY and took some risks and succeeded to become a billionaire.

The TL;DR version of birth of Starbucks: In the book, Schultz shares his struggles of starting with the old Starbucks which was only involved in mail order coffee and shot down his idea of starting to serve coffee in a cafe/bar type retail setting after an inspiring trip to Italy. He wanted to create a comfortable Third Place – a place that people feel comfortable and gravitate towards – after home and office. He decided to quit and started his own company called ‘Il Giornale‘ (meaning, ‘The Daily’ in Italian) and after seeing rapid growth bought the old Starbucks and changed the name of the company.

Schultz also shares the business challenges the company faced over the years and how he was almost muscled out by investors and had to go through crises following failure of coffee crops in Brazil. Other challenges such as partnerships and the risks of brand dilution are also highlighted. But what really stuck from reading it, was his passion for the business. Through thick and thin, he remained focused on creating an amazing work environment for employees and serving customers with the best of the best. Quality of coffee was never to be compromised when dealing with a commodity – as he knew that if they slipped, competition would be ready to pounce.

Interestingly, Schultz also gives a shout out to Nike’s business strategy – and is it a surprise that these two companies are performing so well year after year? In fact, Schultz reached out and hired an ex-Nike branding consultant as its Chief Marketing Officer in 1995 to launch Starbucks as a global brand.

“If people relate to the company they work for, if they form an emotional tie to it and buy into its dreams, they will pour their heart into making it better.”

“Nike is the only other company I know of that did something comparable. Sneakers were certainly a commodity—cheap and standard and practical and generally not very good. Nike’s strategy was first to design world-class running shoes and then to create an atmosphere of top-flight athletic performance and witty irreverence around them. That spirit caught on so widely that it inspired myriads of nonathletes to lace up Nike shoes as well. Back in the 1970s, good sneakers cost $20 a pair. Who would have thought anyone would pay $140 for a pair of basketball shoes?”

“If you want to build a great enterprise, you have to have the courage to dream great dreams. If you dream small dreams, you may succeed in building something small. For many people, that is enough. But if you want to achieve widespread impact and lasting value, be bold.”

Why Invest in Starbucks?

My favorite reason: When you are the go-to name for a legal drug (coffee), you bet on it succeeding 😉

Brand Value: Starbucks Corp is one of the most recognizable, powerful, admired, and valuable brands of the world. This ranking shows how the Starbucks brand is almost always featured near the top of the list in various brand categories. While SBUX still lags against other well-established consumer brands such as Coca Cola (KO) and PepsiCo (PEP), Starbucks has grown by leaps and bounds over the years and has done something to an old easily available old commodity what other companies have failed to do for decades. Think that you missed out investing in Coca Cola or PepsiCo because you were born too late and these companies have already had their bull run? Starbucks is the big global brand to get behind now.

Vertical integration has allowed the company to keep control and maintain the quality of the experience. The brand quality and experience is of utmost importance to Starbucks and the company declines more partnerships than it accepts, fearing brand dilution that may result with wrong partners. The brand value and perception in the economy is not to be taken lightly. Starbucks has always remained at the forefront of treating its employees fairly with a good pay. The company was one of the first to provide comprehensive insurance packages for their entry-level workers – something the restaurant industry resisted and some still resist to this day. Now, Starbucks has launched an education plan helping students with tuition fees. I think these initiatives will go a long way over the coming years on how the brand is perceived and supported by the community.

As mentioned earlier in the ‘2015 Performance’ section, the high revenue growth in Starbucks has propelled the company’s stock price upward. Deep value and (some) dividend growth investors have missed this great company due to the high P/E ratios and low initial dividend, but high growth stocks such as Starbucks should still find a place in each investor’s portfolio. Other writers have already shown how fast growing companies (low yield high dividend growth stocks) can provide better returns over the long run. Over the course of 2015, the growth story has been impressive. Revenue continued to grow at 13% CAGR; consolidated operating income grew at 23% CAGR; consolidated operating margin growth of 410 BPS; EPS growth of 21% CAGR; and operating cash flow growth of 29% CAGR.

This impressive growth comes thanks to its rapid expansion of new stores across the world. In 2015, Starbucks opened 1,677 new stores bringing the total to 23,043 stores in 68 countries. As it stands, Starbucks is well on its way to global domination in coffee/beverages business. In addition, the same store sales have increased handsomely. Same store sales increased 7%, driven by 3% increase in traffic. Americas comp sales increased 7%; China/Asia Pacific comp sales grew at 9%; and EMEA comp sales grew of 4%.

Outlook for 2016 remains just as strong and in-line with the company’s long term growth trend: mid-single digits comp sales growth, revenue growth of 10% (analysts expect 12.9%), and Non-GAAP EPS of $1.87-$1.89 (analysts expect 15.3%).

SBUX-2015-Growth

(Image Source: Starbucks at Morgan Stanley Global Consumer and Retail Conference Presentation)

Starbucks still sees majority of its sales in US (60M US customers vs. total 72M worldwide customers). However, Starbucks is focusing its attention to growing its international operations. The company intends to open 1,800 new net stores in 2016, of which 70% are expected outside US, significantly more in China and Japan. This is good timing from Starbucks as US companies have the tailwind of a strong US$ to invest in international markets. When the tide turns and the US$ starts weakening during the next cycle, the international markets will provide added buoyancy to the financials.

Other metrics also look great for Starbucks. Debt/Equity of 0.40 and Current Ratio of 1.20, a strong balance sheet, and the company continues to increase dividends and buybacks. Starbucks started paying dividends in 2010 and has a 5-year dividend growth rate of 30.45% and has a payout ratio of 27.1%. On the buyback front, Starbucks repurchased $1.4B in common stock in FY2015; and Starbucks last announced a share repurchase program in July 2015 authorizing repurchase of 50M outstanding shares.

Even though Starbucks is a coffee company, it has stayed at the forefront of innovation. Currently, Starbucks is leading the way in new technologies such as mobile payments and innovative ways to buy coffee. Recently, Starbucks appointed a new CTO -Gerri Martin-Flickinger, who brings her 30 years of tech expertise from Adobe Systems. Market and Business Intelligence researcher Scott Galloway, of NYU Stern and L2 Inc has, in his talks, mentioned that Starbucks is a tech company that happens to serve coffee – which I thought provides an interesting perspective.

Starbucks is also now testing serving alcohol and turning the cafe into a late-night hangout place in some US locations. The infrastructure exists – and instead of shutting down the prime real estate locations for the evening or simply accepting the slow hours, starting to serve alcohol and late night snacks can provide a new shot of growth for the Starbucks.

All in all, a great investment story of a company that has continued to grow through leaps and bounds. A strong investment case can be made for Starbucks to continue down this path of rapid expansion over the coming years.

Summary

Starbucks is one of the best run companies with a top ranked brand value that is seeing rapid expansion across the world. The company boasts amazing revenue growth numbers and investors love the stock for that reason. While earnings can be manipulated by share buybacks, there is no such manipulation available for top-line revenue growth numbers. In addition to seeing increased traffic and growth in same store sales numbers, the company continues to open new stores and currently plans 1,800 new stores in 2016 (that’s 4.9 new stores per day!) with 70% of those coming in international markets. My top pick for 2015 was Starbucks and the total return YTD has been approx 50% and I see similar growth and amazing returns in 2016. As a result, my top pick for 2016 is Starbucks once again.

Further Reading: At the beginning of the year, I decided to contact financial bloggers and share their top investment pick for 2016. More than 30 bloggers participated, and their reason for making the pick. Starbucks was picked by two (including yours truly) bloggers. There are some great picks in the list, and I invite you to check them out. The article is available here.

Full Disclosure: Long SBUX. My full list of holdings is available here.

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