by Lawrence Meyers | November 21, 2013 1:30 pm
Starbucks (SBUX) has been piping hot in the last year, with shares of SBUX stock up 60% since November of 2012.
Recently, Starbucks earnings came strong at 63 cents per share of SBUX stock for the fourth quarter — 3 cents ahead of analyst estimates. Plus, the Starbucks earnings report for all of 2013 revealed 23% growth in operating income, along with 7% growth in same-store sales.
And SBUX stock could have even more upside if its Teavana purchase pays off. But that purchase is a pretty big question mark.
So should you bet on Starbucks stock at these levels? Let’s take a look at the pros and cons.
Strong sales. Once again, same-store sales in both the U.S. and China increased 8% during the fourth quarter. After all these years, SBUX continues to be the go-to destination for people who not only want coffee, but some neutral territory to meet at. That was the original and brilliant concept for Starbucks — a place between work and home that people could meet to socialize. Then SBUX tacked on an addictive product to sell and history was made. SBUX stock has consequently faired very well as the concept caught on.
Store growth is strong. SBUX opened over 1,700 new stores in this past fiscal year and plans to add another 1,500 stores during 2014, half of which will be in China. As Starbucks expands its footprint, its earnings should increase and SBUX stock should follow. Once stores are opened, they add cash flow soon thereafter.
Teavana shows great promise. The global tea market exceeds $90 billion, and tea is the second most-consumed beverage after water. Starbucks aims to open over 1,000 locations in the next five to ten years. Already, tea sits in some 80% of U.S. households and CEO Howard Schultz believes that SBUX can do for tea what it did for coffee. Starbucks stock won’t reflect this endeavor for some time to come. But when the stores start to open, SBUX earnings will follow.
Valuation. SBUX stock trades at over $80 as of this writing. Meanwhile, Starbucks earnings for 2014 — not the just-reported year but the next one — are expected to be $2.65. The good news: That’s a 19% increase in Starbucks earnings. The bad news: It means SBUX stock trades at 30x analyst’s estimates. That’s incredibly expensive, even if one gives SBUX stock a premium for having great cash flow.
Danger of over-expansion. Several years ago, Starbucks overexpanded. There were stores everywhere here in the U.S., and I saw as many as four stores within a two-block radius in Los Angeles. As a result, the company had to close a lot of stores and SBUX stock suffered as a result. Now SBUX is at it again with its aggressive expansion, and could overdo it.
Teavana not a slam dunk. Sure, it sounds like the play for tea drinkers will work … and nobody is better at executing than Howard Schultz. However, the worst possible thing for SBUX stock would be if this were an example of Peter Lynch “di-worse-ification.” If Teavana doesn’t pan out, it would mean the $670 million acquisition, plus capital expenditures to open stores, would fail. That would drag down earnings and SBUX stock along with it.
There is a lot to like about Starbucks stock. Two other selling points: Cash flow is amazing at about $1 billion a year, and the company has about $1.70 per share of SBUX stock in cash.
But right now, SBUX stock is trading for a frothy 30 times estimated 2014 Starbucks earnings. At that level, it simply isn’t a good time to buy.
If Starbucks stock falls back to 25x earnings, then I’d buy.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.
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