Why I’m Long Starbucks, and Where to Enter by Zack Raicik

• Posted by scheplick
• on May 30th, 2012

This is a guest post from Zack Raick, a student at Bentley University, and Research and Development Intern at Travelers Insurance. In this post, Raick writes about Starbucks ($SBUX), a company he is long. He says, “Starbucks has the opportunity to increase their stock price by nearly $19 dollars by 2014.” You can follow Zak Raick on StockTwits here.

Over the last two years, I have been in and out of hundreds of companies, but I been long one stock consistently: Starbucks ($SBUX). After falling to nearly $7.00 a share in 2008, they have been providing investors with consistent returns for the last 4 years. * In my opinion they have positioned themselves for future success and will continue to provide double digit returns for investors in the future.

*Starbucks returns compared to S&P500 returns on a percentage basis over the last two years

Despite being part of the very economy-dependent restaurant sub industry, they have managed and will continue to generate increasing revenues for one reason: the experience. When consumers walk into Starbucks they expect more than just coffee. Sure, Starbucks buy’s and roast’s the highest quality coffee beans they can but it is more than that. Each interaction is different, and to a degree personal. It is not out of character to see people working, studying, or just catching up in Starbucks. This genuine service, inviting atmosphere, and outstanding cup of coffee will keep customers coming back despite any economic situation, however, the healing economy is going to help Starbucks. Analysts expect revenues to grow by 15% in FY12.

As we all know, we can’t invest in a company strictly based on their atmosphere or how they look inside. With that being said the following outlines why Starbucks has positioned themselves well for future success and will be able to provide double digit returns steadily into the future.

First, Starbucks ($SBUX) has recently entered the instant serve and single serve coffee market. The K cup business is an 8 billion dollar industry, and is growing. Fast. K-Cups are finding their way into homes, colleges, and businesses worldwide. It allows consumers to bring the coffee they love into their homes and institutions at an affordable price.  According to CFO Troy Alstead, Starbucks currently controls about 20 percent of the single serve coffee market. This is an additional 1.6 billion in revenue and additional 160 million in profit (assuming a 10% profit margin). It follows that this will generate an additional $.21 of EPS and at a P/E of 30 will incrementally increase the stock price by $6.33. These numbers are expected to rise rapidly following the release of their proprietary home brewing system, Verisimo later this year. As they become more experienced at controlling costs with respect to the k-cup industry, Starbucks will be able to leverage this part of their business moving forward and generate a profit for their investors.

Second, Starbucks ($SBUX) has been generating explosive sales growth in China and Asia. This past quarter, sales in china grew more than 20 percent for the seventh consecutive quarter. As a result, Starbucks plans to accelerate store openings in that region from 300 stores in 2012 to 400 stores. Take the current population of China, or 1.4 billion people. If Starbucks can effectively capture just 10 percent of that market by 2014 and the average consumer spends $2.00 at Starbucks, 200 days out of the year, the Chinese market alone will generate incremental revenues of 840 million dollars. Even with the lowest profit margin estimates of 7%, this will add $.07 to EPS. At a P/E multiple of 30, this gives an additional stock value of $2.10. As business becomes increasingly more global, this aspect of their business will become increasingly more important in the future.

In addition to leveraging markets in the K-cup industry and Asia, Starbucks ($SBUX) has pointed to the $50 billion dollar health and wellness industry for supplementary sources of growth. The recent acquisition of Evolution Fresh Inc. for $30 million indicates the company is serious about establishing a presence outside of their own stores. According to the Wall Street Journal, Evolution Fresh products are already carried on the west coast and Starbucks plans to extend the brand to retailers on the east coast, including into its own stores. Let’s assume Starbucks can conservatively capture just 5% of this market by 2014. This would generate incremental revenues of $2.5 billion dollars and a profit of $250 million. If these numbers can be achieved, which I think they will be, this arm of their business will add $.32 to EPS. Again, at a price to earnings multiple of 30, this will add nearly $10 to the price of Starbucks common stock. It is important to point out that this will remove PepsiCo’s ‘Naked’ juice brand from Starbucks stores. This is one way Starbucks will suppress competitor’s sales in this market, allowing themselves to effectively grow in it.

From these three initiatives, Starbucks ($SBUX) has the opportunity to increase their stock price by nearly $19 dollars by 2014. Based on a current stock price of $53 per share, this is almost a 36% return. A consensus industry outlook suggests that Starbucks will have favorable operating conditions for the coming year 2012. In addition, Starbucks’ experienced management team has locked in their coffee prices throughout year 2013. It is clear that everything points to Starbucks generating double digit returns for their shareholders this year, and for many years to come.

To determine the best entry point, you should use the two-period RSI. In terms of the short term, the stock tends to correlate with the RSI_EMA reading pretty well. I would recommend using exaggerated oversold and overbought levels to find the best entry point. I have had the most success using overbought levels of 90 and oversold levels of 10.** Using the current situation as an example, I would look for an entry anywhere below $54.00.

** Sample SBUX entry points

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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