We’re adding Starbucks to our list of US Key stocks. Starbucks is a buy for further long-term share price gains and dividends that have risen each year since it first began paying them.
We added Starbucks (NASDAQ—SBUX) to our list of US all-star stocks in our March 8 issue. Since then, its shares have jumped by 28 per cent. This gives them strong upwards price momentum. Now we’re adding Starbucks to our list of US Key stocks. It remains a buy for further long-term share price gains and dividends that have increased every year since it began paying them in fiscal 2010.
Starbucks has 30,184 coffee shops globally
Starbucks is “the leading retailer, roaster, and brand of specialty coffee in the world”. Retail sales accounted for 90 per cent of last year’s revenue. Starbucks “sells whole bean coffees through its specialty sales group, mail-order business, supermarkets and online”. At last count it operated 9,767 company-owned coffee shops in the US and 5,888 abroad. Starbucks has also licensed 14,529 coffee shops worldwide. We’ve seen great locations in Europe, such as Amsterdam’s train station and a subway station in London’s Hyde Park.
In fiscal 2019, Starbucks is expected to earn $2.80 a share (all numbers are in American dollars). This would represent healthy earnings growth of 15.7 per cent from last year. Based on this estimate the shares trade at a high P/E (Price-to-Earnings) ratio of 32.5 times. Next year (which begins on October 1), Starbucks earnings are expected to grow by 11.1 per cent, to $3.11 a share. Based on this estimate, the shares trade at a better, but still hefty, forward P/E ratio of 29.3 times.
Starbucks’ earnings are also rising thanks to its share buyback program. In fiscal 2013, Starbucks’ share count peaked at 1.506 billion. It has fallen every year since then. At the start of this year, the number of shares outstanding has fallen to 1.211 billion. Spreading the earnings over fewer shares automatically increases the earnings per share, of course.
Starbucks has low operational risk
Starbucks’ hefty P/E ratio adds an element of share price risk. But Starbucks exposes you to low risks in other ways. First, its growing geographical diversification reduces its sensitivity to an economic slowdown in any country other than the US. Second, this also reduces its risk from natural disasters.
A third factor making Starbucks safer is that it’s largely immune to, say, technological change. Even as technology advances, people will keep drinking coffee. Even solitary writers often do their work in Starbucks’ shops. And once the company has perfected its coffee shop model in each market, it can simply open more outlets with little risk.
Starbucks’ MGI (Marpep Growth Index) is 0.5. Since this is less than 1.0, it suggests that Starbucks is somewhat overvalued. The thing is, the shares just keep on going up. A decade ago, for instance, Starbucks traded at an average price of $8.05 a share. Today the shares are up by more than 11 fold. With momentum on their side, the shares could simply rise further.
Starbucks is profiting from tailwinds
Starbucks’ earnings are benefiting from several tailwinds. One was a better effective tax rate of only 20.6 per cent or so. This put more of the revenue into the company’s pockets. A second tailwind was strong profit margins despite upwards pressures on wages. A third was more digital business. The Mobile Order & Pay program, for instance, is popular in both the US and China. A fourth tailwind was a strong customer response to improved rewards programs. This raised the average size of orders.
Starbucks has established a joint venture with PepsiCo to develop bottled coffee drinks. Starbucks has also set up a joint venture with Dreyer’s to develop ice cream drinks. Both should increase sales in the afternoons, which are slow after the morning rush. Cold drinks, in particular, are likely to appeal to consumers during heat waves.
Starbucks’ dividends keep growing
In fiscal 2010, Starbucks paid its first dividends. That year it paid 10 cents a share. The company is expected to pay dividends of $1.78 a share this year. Despite paying much higher dividends, it yields less than two per cent. That’s because Starbucks’ share price has gone up so much.
Were it a Canadian company, Starbucks would qualify as what’s known as a ‘dividend aristocrat’. That’s because it has raised its dividend for more than five years in a row. In the US, however, dividend aristocrats are companies that have raised their dividends for 25 consecutive years. We expect Starbucks to continue to raise its dividends each year.
The US is Starbucks’ most important market, of course. China is its second-most important market. Starbucks has done well in China. But one potential risk is an even worse trade war between the two countries. This could lead some Chinese to switch from Starbucks to local chain Luckin Coffee.
Starbucks’ directors and officers own four per cent of the common shares. That’s worth about $4.413 billion. With so much money on the line, management’s interests are similar to yours.
Starbucks remains a buy for further long-term share price gains and dividends that have increased every year since it began paying them in fiscal 2010.
This is an edited version of an article that was originally published for subscribers in the August 9, 2019, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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