Near-Term Investments Should Position Starbucks Well for Long-Term Category Gains

Business Strategy & Outlook:

Starbucks is the largest specialty coffee chain in the world, generating some $29 billion in sales during fiscal 2021. The firm’s attention to premium-quality coffee distinguishes it from chained competitors (alleviating pressure from quick-service restaurant competitors and at-home consumption), allowing Starbucks to charge substantially higher prices while creating a buzz around what has historically been a commoditized product. While the subindustry has attracted significant competitive attention, Starbucks’ premium positioning has allowed the firm to outflank competitors, leveraging its brand to raise prices 6.8% annually in the U.S. over the last five years, healthily in excess of category inflation. Commanding unit economics, with payback periods in the ballpark of a year and a half (against three to six years in the broader QSR space), should pave the way for mid-single-digit unit growth through 2031, as the firm increases penetration in its core company-owned markets (the U.S. and China), and with license partners in more than 80 global markets.

Starbucks’ recent strategic focus on streamlined operations, adjacent menu innovation, digital engagement, and selective store closures strikes us as appropriate, with new openings concentrated in underpenetrated middle America and Chinese markets. While the firm’s trade area initiative created growth headwinds in 2020, as the firm closed 800 underperforming units in the U.S. and Canada, it should provide a durable foundation for unit development as the chain adjusts to a world that seems poised to skew toward off-premises sales, closer to home. Finally, the firm’s ongoing investments in its loyalty program, with nearly 27 million active users in the U.S. at the end of the second quarter of 2022, should resonate with an audience that has grown increasingly amenable to digital ordering, with more than half of order volume now driven by program participants. Starbucks remains a compelling long-term “growth at scale” story and the anticipating average top-line growth of nearly 11% through 2026 and adjusted EPS growth averaging 12.2% in base-case scenario.

Financial Strengths:

Starbucks’ financial strength as sound. The company targets a lease-adjusted debt/EBITDAR of 3 times, consistent with an investment-grade credit rating. The calculations suggest that it was in compliance with this target at the end of fiscal 2021, with a lease adjusted debt/EBITDA ratio of 2.6 times. The firm also has access to an untapped $3 billion credit facility and a $3 billion commercial paper program. With few hard assets, the operating income-based leverage metrics are a more appropriate proxy for restaurant businesses’ liquidity and solvency. Starbucks’ debt/EBITDA returned to normalized levels in fiscal 2021, finishing the year around 2.3 times leverage, well below 5.3 times during a trying 2020. The EBITDA/interest coverage (11.6 times) in fiscal 2022. Starbucks’ strong free cash flow to the firm conversion (averaging 8.9% of sales through 2024) offers the flexibility to invest in technological improvements, new restaurant openings, and menu innovation. The firm shall prioritize growth capital expenditures (estimated at $5.7 billion through 2024), dividends ($7.2 billion), and share repurchases ($11.5 billion), with management targeting a long-term 50% dividend payout ratio. While share repurchases were suspended during the second quarter of fiscal 2022, and expect them to be ultimately reinstated in fiscal 2023 based on the firm’s investment opportunity priorities and $4.0 billion in cash and cash equivalents on the balance sheet at the end of the second quarter of fiscal 2022.

Bulls Say:

Starbucks’ “stars for everyone” initiative should drive continued adoption of the firm’s loyalty program, materially increasing customer lifetime value.
Leading market share in China and exposure to a growing middle class contribute to a compelling growth narrative for the company.
Strength in the cold beverage platform could drive volume toward underpenetrated afternoon dayparts, helping prop up average unit volume with minimal incremental labor costs.

Company Description:

Starbucks is one of the most widely recognized restaurant brands in the world, operating nearly 34,000 stores across more than 80 countries as of the end of fiscal 2021. The firm operates in three segments: North America, international markets, and channel development (grocery and ready-to-drink beverage). The coffee chain generates revenue from company-operated stores, royalties, sales of equipment and products to license partners, ready-to-drink beverages, packaged coffee sales, and single-serve products.

(Source: Morningstar)

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