A Prosperous Year Awaits Starbucks Corporation (SBUX)

American coffee company Starbucks Corporation (NASDAQ:SBUX) just announced its 1Q13 earnings; the company met its earnings estimates as it reported a 13% rise in its profits. As a result, Starbucks’ stock closed at an eight month high of $56.81 on Friday.

Starbucks Corporation (NASDAQ:SBUX) Earnings

The figure that was of foremost importance to the company was a 6% rise in sales at cafes open at least a year. According to the company, its strong results clearly show that the company outperformed its competitors even in a tough market. Starbucks reported earnings of $432.2 million ($0.57 per share), up from earnings of $382.1 million last year. Analysts were expecting earnings of $0.57 and revenue of $3.8 billion. The company’s revenue grew 11% from the last year whereas its operating margin increased to 16.6%. Moreover, in the U.S. and Americas, the company saw sales growth of 7%.

Holiday Season

Though most of the players in the restaurant industry didn’t have a great holiday season, Starbucks did very well thanks to its “Starbucks card.” It was one of the most widely gifted items in the season, with one in 10 U.S. adults receiving it. Plus, its first ever steel Starbucks cards worth $2 million were sold over the Internet in just six minutes.

Verismo

In September, 2012, the company launched its new coffee making machine “Versimo” at Starbucks online. As more than 150,000 machines have been sold so far, the company expects a lot from Verismo in the years ahead. According to the company, if Verismo keeps on doing well, it could be a multi-billion dollar deal for the company in the future.

Global Expansion Plans

In the Asian Pacific/Chinese region, Starbucks is currently operating in 12 countries. The company has plans of growing to 4,000 stores in the region, with the main focus on Japan (1,000 stores) and Korea (500 stores).

Starbucks’ major focus is on China where the company has 700 stores and plans on having more than 1,500 stores by the end of 2015. As far as India is concerned, Starbucks received an awesome customer response from its first four stores in Mumbai. As a result, the company will also be opening its first store in New Delhi next month. In the EMEA region as well, the company’s Q1 transactions were far greater than 1Q13. The company now has 500 stores outside U.K and continental Europe amid strong growth in the Middle East, Russia and Turkey.

Valuation

Starbucks is currently trading at a forward P/E of 21.38x; using the industry’s P/E of 22.9x, we can value Starbucks. As Starbucks is expected to perform well above the industry, we would use a premium of 10% while valuing its stock. Hence, an earnings multiple of 25.19x would be used.

Using consensus estimates, we value Starbucks’ stock at $66. Hence, it has an upside potential of almost 18%. In addition to capital appreciation, a dividend yield of 1.50% yields a total return of 19.50%.

Coffee Industry

Though Starbucks is doing great, it will face relatively tough competition in the upcoming years. McDonald’s Corporation (NYSE:MCD), Green Mountain Coffee Roasters Inc. (NASDAQ:GMCR) and Dunkin Brands Group Inc (NASDAQ:DNKN) share the coffee market with Starbucks. Despite the fact that McDonald’s didn’t do that well in 2012, its McCafe coffee had a great year. McCafe has done so well in the last year that McCafe customers have almost outnumbered McDonald’s regular “burger” customers. The core reason behind it is McCafe’s reasonable coffee prices. McDonald’s released its 4Q12 earnings on Jan. 23; though the company beat its estimates by reporting an EPS of $1.38, it still had an average year.  In 4Q12, the company reported a 0.2% increase in sales at restaurants open at least a year. According to the company, this sales figure is of foremost importance to the company as it tells how much the company is making on net new restaurants opened (new restaurants less restaurants closed). In 3Q12, this figure dropped to a record low of 2.2%. As a matter of fact, we remain neutral on McDonald’s in the short run.

On Nov. 28, 2012, Green Mountain Coffee Roasters rose to a record high of $39.86 as the company reported a 22% rise in profits for 4Q12 amid huge K-Cup sales. In order to reduce its dependence on a single partner, GMCR is still adding more K-Cup licensees; the company doesn’t sell more than 6% of its K-Cups to a single partner. GMCR’s latte and cappuccino making “Vue machine” has shown a lot of promise lately and is giving Nestle’s Nespresso stiff competition. With GMCR’s patents for the K-Cups expiring last year, companies like Starbucks can cash in on this huge opportunity. Therefore, GMCR’s 1Q13 earnings, which are expected to be released on Feb. 6, would give the market a fair idea about its K-Cup sales. At this moment, we remain neutral on GMCR just like MCD.

Conclusion

Starbucks’ global expansion plans and Verismo are the biggest catalysts for the company in the coming years. China will remain one of the biggest markets for Starbucks where the company expects to see more than 1,500 stores by 2015. With Versimo doing really well in the market, Starbucks is expected to capture a huge market share through its K-cups, capsules, pods and portions.

One thing the company should realize is that it can’t remain that expensive relative to its peers. With more affordable brands like McDonald’s and Dunkin’ doing well, Starbucks should try to lower its prices to some degree. Dunkin’ has already expanded itself in the Northwestern region and expects to open more than 15,000 stores by the end of 2020. However, McDonald’s and Dunkin’ beating Starbucks in the near future still remains a distant call. At present; with an expected return of almost 20%, Starbucks is still the global leader in the coffee market and remains one of the top buys in the industry.

The article A Prosperous Year Awaits This Giant originally appeared on Fool.com and is written by Adnan Khan.

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