Investment Thesis:
Premium roast coffee producer SBUX offers investors an opportunity to capitalize on a company with a strong financial position within its industry. The main prosperous reason for SBUX future performance entail: growth opportunities in China, a strong and diversified portfolio strategy in America segment, and dominance in the global coffee category
Company Background:
Starbucks is the leading roaster, marketer, and retailer of specialty coffee in the world. The company sell high-quality roast coffees, handcrafted coffee, tea and other beverages and a variety of high-quality food items
Segment Financial Information
Starbucks has three reportable operating segments: 1) Americas, which includes U.S., Canada, and Latin America; 2) international, which includes China, Japan, Asia Pacific, Europe, Middle East, and Africa; 3) Channel Development. In figure 1, it displays Starbucks revenue from operating segment as a percentage of total net revenue for fiscal 2020.
As illustrated in figure 1, we can see that Americas is the leading segment for 70% of total net revenue. America’s segment is more mature business and has reached considerable scale.
The international segment lags and may require more extensive support, as it only contributes 22% of total net revenue for fiscal 2020. Lastly, the channel development segment revenue includes roasted whole bean and ground coffees, Seattle’s Best Coffee, Teavana iced tea, and other branded product sold worldwide outside of the company, representing 8% of total net revenue for 2020
Revenue Components
Starbucks created most of their revenue through company-operated and licensed stores. Revenue from company-operated stores accounted for 81% and licensed stores accounted for10% of total net revenue in fiscal 2020. As illustrated in figure two, the number of stores Starbucks opened as of Sep 27, 2019, and 2020 were as follow: 1) America accounted for 9,974 as of 2019increased to 10,109 stores as of 2020 (1.4%); 2) International accounted for 5,860 as of 2019 and increased to 6,528 stores in 2020 (11.4%). Starbucks stores are typically located in high traffic, high visibility locations.
The percentage sales of mix product for Starbucks company-operated stores are as follow: beverages (75%), food (20%), packaged and single-serve coffees and teas (1%), and other (4%). Other revenue is recorded in Starbucks Channel Development segment and includes sales of packaged coffee, tea, and ready-to-drink beverages.
Reasons to Buy
Growth Opportunities in the international segment- China
Starbucks is the largest specialty coffee chain in the world and plans to become an even bigger competitor in China. Starbucks has open 5000 stores in China, and it expects to reach 6000 stores in 200 cities by the end of 2022. The company is closing underperforming stores and is strategically opening stores in large daylight populations to increase revenue margins.
The international segment, heavily skewed toward China, highlights 11.3% annual growth (excluding 2021), which is mainly driven by a new unit opening of 8.5%, as Starbucks remains confident in expanding its stores all around China.
Diversified Portfolio Strategy in America Segment
Starbucks ’ America segment is the most mature business and has accomplished considerable scale. The America segment accounts for 70% of Starbuck’s revenue, 22% accounts for international, and 8% towards channel development. As of 2020, the America segment has reached a total of 18,354 stores compared to 14,306 stores in the international segment. The firm objective is to maintain Starbucks standing as one of the most recognized and respected brands. The firm is focusing on expanding its stores, adding more stores across U.S. lands, and adopting consumer preference.
Dominance in the Global Coffee Category
Starbucks is the largest specialty coffee chain in the world, with $23.5 billion in 2020 revenue indicating nearly 9% of the aggregate café market worldwide—while Dunkin represents only 8.9 billion and 3%, respectively. The firm has achieved record unit volumes than competitors, with the U.S. stores accounting for $1.5 million AUV, outpacing Dunkin’ ($970,000), Tim Horton’s ($1 million), Peet’s ($1.46 million), and Caribou ($700,000).
While the specialty coffee space has drawn significant attention, Starbuck’s prestigious ranking has allowed the firm to outpace the aggregate market. The average annual price increases in the Americas segment are 5.2% and unit opening of 4.1% proficiently outperforming the industry (0% and 0.1%, respectively). The firm dominance in severing high-quality coffee allows Starbucks to charge substantially higher prices.
Outperforming its Peers
When compared to peer’s valuation, SBUX trades at a significant premium on an EV/EBITDA, EV/EBIT, and P/E basis. Though this can be attributed to the higher margin, it leaves one to question whether this future success has already been priced in and maybe highly speculated.
The company is currently undergoing a high historical valuation level and remains very competitive in the restaurant industry. The firm will experience a high growth rate in the future.
A P/E of 130.82x could indicate two situations, Starbucks stock is over-valued, and investors are expecting high growth rates in the near-term futures. Based on wall street estimates, the company is expecting to generate $28,790 billion in revenue in 2021, which represents a 22% increase in revenue from 2020 revenue.
Risks:
Risk Related to Competition
The company is facing intense competition in each of its channels and markets, which could lead to reduced margins. In the U.S., there are large competitors in the quick-service restaurant severing high-quality coffee beverages, which could lead to lower order volume to Starbucks stores. Many small competitors are entering the coffee market around the U.S., which in aggregate may also lead to a significant decrease in customer traffic to Starbucks stores.
Risk Related to Operating a Global Business
Starbuck’s financial performance is heavily dependent on the American operating segment. The America segment is the most mature business, and it generates approximately 70% of consolidated total net revenues in fiscal 2020. Any downside in the American segment can result in reduced cash flow for funding the expansion of the international segment and for shareholders.
Risk related to international business
Starbucks operates in over 80 markets globally. The international segment is subject to additional risk related to the following: foreign currency exchange rate variations, changes in economic, legal, regulatory social, and political; the condition in our markets, as well as the undesirable effect on U.S. business due to growing anti-America sentiment in certain markets; and clarification and application of law and regulation, including tax, tariff, labor, merchandise, anti-bribery and privacy laws, and regulations.
Risk in price fluctuation
The second-largest cost variable, green coffee accounts for 15%-20% of COGS, which is also sensitive to price fluctuation. Coffee purchasing also signifies the firm’s largest EGS risk exposure, with supply chain human rights concerns and the environmental impact of coffee farming possibly attracting increased scrutiny in the future. This potential risk could affect Starbucks ‘ ability to increase its gross margin of (22% gross margin in fiscal 2020).
Competitive Positioning:
Threat of New Entry
The barrier of entry is not high enough to discourage new competitors to enter the market. Many start-ups specialty coffee shop is entering the market to compete with elite players like Starbucks and Dunkin. Fortunately, Starbucks has grabbed a large market share based on its infrastructure, efficiency, and product quality reputation. Thus, allowing the company to continue increasing customer traffic and attracting new members with their new launch of stars reward digital relationship. As a result, the threat of new entry is moderate.
Threat of Substitution
The number of substitution products for the Starbucks brand coffee is high. There is plenty of beverages substitution available in the market (from juices to tea and alcoholic beverages). Another form of threat is the homemade packaged coffee product that customers make at home. While this threat remains high for Starbucks, the firm also sells premium packaged coffee and coffee makers to lessen the threat of substitution. Starbucks benefits from its better-quality coffee and easy access from suppliers globally. As a result, the threat of substitution is moderate high.
Supplier Power
Suppliers can exercise only low to moderate pressure on Starbucks. The brand has its supplier diversity policy that helps to choose the suppliers. The firm is growing with the coffee farmer directly. This relationship with coffee farmers allowed Starbucks to gain higher control over its supply chain. Even though the number of suppliers is high, Starbucks has plenty of room to exercise choice. Its outstanding supply chain management in the last decade has diminished the bargaining power of suppliers and brought it low. As a result, the threat of supplier power is low.
Buyer Power
The size of individual purchases is small and so single buyers do not hold enough power. Starbucks customers are mostly quality sensitive and ready to pay a top price for premium quality products. However, the price of coffee cannot be excessively high because loyal customers watch for sudden price trends and would start switching to alternative coffee shops. As a result, the threat of buyer power remains low.
Competitive Rivalry
The concentration of competitive rivalry in the industry is moderate-high. It is because competition in the industry and the number of firms competing for market share are high. The entry and exit barriers are small. The main reason that moderates the competition for Starbucks is its market share. It has the maximum market share followed by Dunkin and McCafé. Nevertheless, the exceptional quality and product-based variation that Starbucks uses allow it to gain some edge to compete with competitors. However, the industry has developed, and the growth rate has weakened as high number of players are competing for market share. Yet, there is always room in this industry for new competitors, which enhances the intensity of competition in it. As a result, the threat of competitive rivalry is moderate high.
Monitoring Point
Monitoring Points:
Economic conditions in the U.S. and international markets could adversely affect our business and financial results
In the fiscal year 2020, Starbucks reflected challenges with the COVID-19 pandemic, which severely impacted financial results, particularly during the second and third fiscal quarters. Consolidated revenues declined 11% to $23.5 billion in fiscal 2020 compared to $26.5 billion in fiscal 2019 driven by temporary closings of a considerable amount of our company-operated and licensed stores, as well as reduced business operations and decreased customer traffic.
There is a potential risk that Starbuck could face revenue losses in the following years, because of increasing cases of covid-19. If just scenario occur Starbucks will face similar measures and revenue declines seen in the recent COVID-19 pandemic. The closure of Starbucks stores around the world could interfere with Starbucks plans with expanding their international exposure and reaching 6000 stores in 200 cities around China by the end of 2022.
