Too Much Foam at Starbucks?
Probably our most popular article to date has been Starbucks vs. McDonalds, in which we look at McDonalds’ current market cap to get an idea of what Starbucks may achieve over the next 10 years. At the time, we noted that the return potential implied by that comparison was mediocre:
However, as we pointed out, SBUX is more efficient than MCD, which is reflected in a 20.8% ROE for SBUX compared to 17.7% for MCD. And MCD has debt funding which boosts its ROE. As growth slows at SBUX it too could add some debt to its mix to generate better returns for equity holders. But at any rate, the 3 per cent differential in ROE says that SBUX should be more valuable than MCD when it finally tops out. Looking up the fundamental P/E calculation on p. 192 of Analysis of Equity Investments: Valuation, we can get a good starting point. If we adjust the payout ratio to give us the same implied growth rate and required return for Starbucks as we currently have for MCD, we find that SBUX would deserve a 23.2x P/E multiple rather than the 17.3x that MCD has today. And assuming further that SBUX achieves the same debt/equity mix it could justify a $66.5 billion enterprise value. If we get there the average annual return would be more like 8.5 per cent, which is a good deal better but still may not justify the price now unless one is willing to bet that SBUX can, indeed, grow to a larger size than McDonalds (or if one assumes the average return on other investments will be less than that.)
The Average Joe Investor has now weighed in with his take on Starbuck’s valuation. Although he takes a different route to get there, the conclusion is similar:
SBUX trades at 46x the current EPS estimates for 2006 - that’s a nice 2.3x a 20% five year growth rate. And this is after shedding 12% since the first part of May. I think there’s a great company behind the SBUX ticker, but you’re not going to get me to pay that kind of a price for it. My take is that people may be a little too worked up about music and movies (which ‘Bucks is using to enhance customer experience to sell more coffee not necessarily to be a big new source of growth) and letting the fundamentals fly out the window.
I think SBUX has a good amount of room to fall to become interesting in the least, and a heck of a lot of room to fall before it becomes a buying opportunity.
Bottom Line: HOLD
Disclosure: Author is long Starbucks (SBUX) at time of publication.
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