Starbucks’ Stock Looks Full at $40

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SBUX: Starbucks logo
SBUX
Starbucks

Starbucks (NASDAQ:SBUX) has been an investor favorite this year delivering 35% year to date gains, but now with the stock around $44, Starbucks’ valuation looks full in our view. Investors who are hoping for better-than-expected results each quarter might be disappointed as the mitigating factors such as spiraling coffee prices could overshadow the company’s growth. Starbucks’ competitors in the broader market for specialty coffee include McDonald’s (NYSE:MCD), Caribou Coffee (NASDAQ:CBOU) and Peet’s Coffee (NASDAQ:PEET).

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See full analysis for Starbucks here

High Coffee Prices

Coffee prices in 2011 are much higher compared to the years 2009 and 2010. Starbucks usually purchases coffee through fixed-price contracts and therefore might have avoided the high coffee prices in 2011. However, it may not be able to escape the rising coffee prices. The cost of goods as a percentage of total net revenues was 42.2% for the entire year while that figure for the third and fourth quarters stood at 42.5% was 44%, respectively. This shows the cost of goods (as a % of total net revenues), which primarily consists of coffee, has been increasing with each quarter.

Weak Comps sales

On the face of it, the numbers look impressive. The company registered a 8% increase in same store sales. However, the international segment witnessed only a 5% increase, that too primarily driven by gains in foreign currency translation. The same-store sales increased by 8% in the U.S., a large chunk of which can be attributed to the price hikes by the company. Further price hikes will force consumers to shift to cheaper alternatives such as McCafe, or Dunkin’ Donuts (NYSE:DNKN). In the face of rising costs, the company might find itself in a precarious position of not being able to increase prices.

Lower International Operating Margin

The operating margin for the international segment has continued to remain below that of the U.S. segment. Expansion is mainly expected to come from the international segment and, as the proportion of revenues generated by this segment increases, we’ll see the operating margin facing downward pressure.

The overall operating margin for fiscal 2011 was 14.8% while that for the international segment was 13%. Furthermore, it decreased to 12% in Q3 and Q4. We also think Starbucks’ China expansion can be thwarted due to purchasing power disparity, and the company may have to choose one between revenue growth and operating margin.

We estimate a $39.80 price for Starbucks, which is about 10% below the current market price.

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