2015

ZAYED

UNIVERSITY

Hamda

[INVESTMENT SPRING 2015 SEMESTER PROJECT]

Starbucks Corporation

Table of Contents

COMPANY INTRODUCTION 4

WHAT IS INTRINSIC VALUE 5

DIVIDEND HISTORY 6

PRICE DATA 6

FINANCIAL RATIOS 6

GROWTH RATE CALCULATIONS 6

INTRINSIC VALUE METHODS 8

Constant perpetual growth model 8

Two stage dividend growth model 9

Residual Income model 10

Price to earnings ratio model 11

Price to cash flow ratio 13

CONCLUSION 14

BIBLIOGRAPHY 15

Appendix 15

Conc. Growth Model 15

16

Two Stage Divi. Growth Model 16

16

Residual Income Model 16

16

Price to Earnings Ratio 16

17

Price to Cash flow Ration 17

17

COMPANY INTRODUCTION

Starbucks Corporation has started their operation in the year 1971. Before 1971, they were in the business of roaster and retailing of whole bean and ground coffee at the store in Seattle’s Pike Place market. The company’s mission is to inspire and nurture the human spirit- one person, one cup and one neighborhood at a time. The company has more than 17000 stores in 50 countries. The company believes in serving the best possible quality coffee. The company has its goal of providing the highest standards of quality using ethical practices. The company understands the importance of employees and says that our employees are the heart of the Starbucks Experience. The company put more emphasis on customer service. The company has more than 30 blends and single-origin premium Arabica coffees.

WHAT IS INTRINSIC VALUE

Intrinsic value is the value of a company based on fundamental analysis without using current market price. Intrinsic value is also called fundamental value of the company. The investor can utilize intrinsic value before taking investment decision. Comparison of market price and intrinsic value shows that whether share is undervalued, overvalued or fairly valued.

Current market price < Intrinsic value undervalued
Current market price = Intrinsic value fairly valued
Current market price > Intrinsic value overvalued

There are basically seven methods of intrinsic value calculation of the company namely Net Working Capital and Net Current Asset Value, Discounted Cash Flow (DCF) Stock Valuation and Reverse Discounted Cash Flow, PE Model for Stock ValuationAsset Reproduction Value, Benjamin Graham Valuation Formula, Earnings Power Value (EPV) by Bruce Greenwald,. We will go for detail study of five methods and compare the intrinsic values of them.

DIVIDEND HISTORY

The first step for intrinsic valuation report is to select the company who has paid the dividend in the past. On the basis of this criteria, we have selected the Starbucks Corporation for analysis purpose. The company has dividned payment history for last 5 years ans more. The dividend history of last 5 years is required for the calculations.

PRICE DATA

The next step is to collect the price data of the starbucks corporatio. The company is listed on the NASDAQ and the ticker symbol is SBUX. The primary data like share price on 31st March 2015 is collected using this ticker symbol. The share price on 31st March 2015 was $47.35.

FINANCIAL RATIOS

The next step is to calculate different financial ratios. These ratios includes ROE (Return on Equity), EPS (Earning per share), Book value per share, dividend payout ratio, price earning ratio, EPS growth rate, Price/Cash flow ratio, Cash flow per share growth rate. The financial ratio calculations are given in the excel sheet. These ratios are the base for the finding the intrinsic value of the share as per the different methods.

GROWTH RATE CALCULATIONS

The next step is to calculate different growth rates namely Arithmetic average, Geometric average and Sustainable growth rate. The calculations are given below.

Year Dividend % change

2010 $0.18

2011 $0.28 55.56%

2012 $0.36 28.57%

2013 $0.45 23.61%

2014 $0.55 23.60%

2015 $0.64 16.36%

ARITHMETIC MEAN = (a1+a2+a3+⋯..an)/n

= (55.56% + 28.57% + 23.61% + 23.60% + 16.36%)/5

= 29.54%

GEOMETRIC MEAN = √(n&a1*a2*a3*………an)

= √(5&55.56% * 28.57% * 23.61% * 23.60% * 16.36%)

=27.05%

Year ROE Retention rate Sustainable growth rate = ROE X Retention Ratio

2010 28.96% 74.50% 21.58%

2011 29.29% 67.26% 19.70%

2012 28.04% 62.18% 17.44%

2013 2.28% -472.00% -10.76%

2014 48.37% 67.07% 32.44%

2015 47.62% 66.24% 31.54%

INTRINSIC VALUE METHODS

Following are the different methods of intrinsic value.

Constant perpetual growth model

The constant perpetual growth method determines the current price of the security using the dividends, the dividend growth rate and investor’s required rate of return. This method assumes that the dividend will grow at a constant rate “g” for the life time. (it is called perpetual)

The Comparison of all 3 rates with expected rate of return shows that growth rates are higher than the expected rate of return. In this case, we have to use industry growth rate as “g” and expected rate of return.

Starbucks Corporation Company is belongs to coffee industry and this industry is expecting the growth of 6.00% in coming years. (Markets, 2015). Expected rate of return is 16.21%. (It is given in the company profile and declared by company.)

Year Discount Rate Industry Growth Rate D1 k-g Intrinsic value

2010 16.21% 6.00% $0.19 10.21% 1.886386

2011 16.21% 6.00% $0.30 10.21% 2.934378

2012 16.21% 6.00% $0.39 10.21% 3.772772

2013 16.21% 6.00% $0.48 10.21% 4.663565

2014 16.21% 6.00% $0.59 10.21% 5.763957

2015 16.21% 6.00% $0.68 10.21% 6.70715

As per the constant perpetual growth model, intrinsic value is $6.71. Starbucks Corporation share price on 31st March 2015 is $47.35. Comparison shows that intrinsic value is lesser than current price which indicates that company’s share is overvalued.

Two stage dividend growth model

This method consists of two different growth rates for availing the intrinsic value. This method assumes that the firm grows at g1 rate for t years. In the second stage, the company will grow at a rate of g2 during perpetual stage of growth. This method is based on dividend as dividends are more stable as compare to the earnings. The company has more stability for dividend. The calculation is as follows.

For Starbucks Corporation, g1 = 12.06%, which is based on past 5 years growth rate. Discount rate k is 16.21% which is given in the company profile. Growth rate g2 (industry growth rate) is 6%.

Year Dividend Level 1 Level 2 Intrinsic value

2010 $0.18 0.770914 1.558074 2.328988

2011 $0.28 1.199199 2.423671 3.62287

2012 $0.36 1.541827 3.116149 4.657976

2013 $0.45 1.90587 3.851906 5.757776

2014 $0.55 2.355569 4.760783 7.116352

2015 $0.64 2.741026 5.53982 8.280846

Two stage dividend models suggest intrinsic value of $8.28. This method also shows that the share is overvalued as market price $47.35 is higher than intrinsic value of $8.28.

Residual Income model

The residual income model is based on book value per share, Earning per share and earnings per share growth. This method taken into consideration, expected EPS for the calculation of intrinsic value.

Year Book value per share EPS Intrinsic Value

2009 2.245 0.374

2010 2.734 0.683 5.48838

2011 3.202 0.833 6.76754

2012 3.451 0.932 7.64695

2013 3.23 0.066 -1.2109

2014 3.848 1.651 14.8793

2015 4.003 1.701 15.3073

According to Residual Income method, intrinsic value of Starbucks Corporation is $15.31 while the market price on 31st march was $47.35 which is higher than the intrinsic value. This method shows the overvaluation of the share as the market price is higher than the intrinsic value.

Price to earnings ratio model

This method is based on 5 years average P/E ratio current EPS, and EPS growth rate. This method calculate expected EPS based on EPS growth rate and compared it with the average price earnings ratio to calculate intrinsic value of the share.

Year EPS EPS growth rate

2009 0.374

2010 0.683 0.8272727

2011 0.833 0.2190518

2012 0.932 0.1185932

2013 0.066 -0.928962

2014 1.651 23.939577

1st quarter of 2015 1.701 0.0302847

5-year average P/E ratio 86.71

Current EPS $1.70

EPS growth rate 4.84%

Expected stock price = Historical P/E ratio ´ projected EPS

= 86.71 x ($1.70 x 1.0484)

= $154.63

According to this method, intrinsic value is $154.63 as compared to the market price on 31st March 2015 of $47.35. The intrinsic value is higher than the market price and it suggests undervaluation of the share.

Price to cash flow ratio

This method is based on 5 years average price to cash flow ratio, cash flow per share and cash flow per share growth. The price to cash flow ratio shows relation between market price and cash flow of the company. CFPS is the ratio between total cash flow and number of equity share.

Year P/CF ratio CFPS

2009 0.7256

2010 21.66 0.7416

2011 32.78 0.5509

2012 29.46 0.9104

2013 34.08 -0.4739

2014 27.9 1.47

2015 32.64 1.533

5-year average P/CF ratio 31.67

Current CFPS $1.53

CFPS growth rate 0.6398

Expected stock price = historical P/CF ratio X projected CFPS

= 31.67 x ($1.53 x 0.6398)

= $31.06

This method requires average P/E ratio of last 5 years which shows relation between company’s price and earnings. This method shows intrinsic value of $31.06 as compare to market price of $47.35. The comparison results shows overvaluation of the share price.

CONCLUSION

The intrinsic value is different for all the investor and the difference is due to their expected rate of return and the method for calculation. As we have calculated intrinsic value with the five different methods, all methods shows different results. Starbucks Corporation intrinsic value shows that the shares is overvalued but the price to earning ratio method shows different result and suggest that the share price is overvalued. The major difference is due to 5 years average P/E ratio value that we have used in price to earning method. The last 5 years financial data comparison shows that 4th quarter of 2013 shows some negative results as compared to other financial year results. The company has good market share as well as profitability, it could be profitable to invest in the company in the long run though intrinsic value shows different picture.

BIBLIOGRAPHY

annual reports. (2015, 31 3). Retrieved 4 29, 2015, from http://investor.starbucks.com: http://investor.starbucks.com/phoenix.zhtml?c=99518&p=irol-news&nyo=0

companies – SBUX. (2015, 4 29). Retrieved 4 29, 2015, from https://ycharts.com: https://ycharts.com/companies/SBUX/eps_ttm

Company, A. T. (2015, 4 25). Markets. Retrieved 4 25, 2015, from money.cnn.com: http://money.cnn.com/quote/quote.html?symb=JNJ

Corporation, 2. S. (2015, 4 25). about us. Retrieved 4 28, 2915, from http://www.starbucks.in: http://www.starbucks.in/about-us/company-information

dividend-stocks. (2015, 4 28). Retrieved 4 29, 2015, from http://www.dividend.com: http://www.dividend.com/dividend-stocks/services/specialty-eateries/sbux-starbucks/

Markets. (2015, 4 25). Retrieved 4 28, 2014, from http://www.foodnavigator-usa.com: http://www.foodnavigator-usa.com/Markets/Packaged-Facts-2014-US-retail-foodservice-coffee-market-report

NASDAQ. (2015, 4 30). NASDAQ. Retrieved 4 30, 2015, from https://www.stock-analysis-on.net: https://www.stock-analysis-on.net/NASDAQ/Company/Starbucks-Corp/DCF/Present-Value-of-FCFF

Research & Analysis. (2015, 4 25). Retrieved 4 26, 2015, from //www.stock-analysis-on.net: https://www.stock-analysis-on.net/NYSE/Company/SBUX/DCF/DDM#Intrinsic-Stock-Value

symbol. (2015, 4 29). Retrieved 4 29, 2015, from http://www.nasdaq.com: http://www.nasdaq.com/symbol/sbux/historical

Appendix

Conc. Growth Model

Two Stage Divi. Growth Model

Residual Income Model

Price to Earnings Ratio

Price to Cash flow Ration