Despite its large size, Starbucks Corporation (NASDAQ:SBUX) had a quite successful second quarter of its fiscal year (Q2 ended in March), with the company’s revenue growing 11% versus a year earlier fueled by comparable store sales of 6%. In geographic terms, the Americas experienced sales growth in line with the overall numbers; higher growth rates in Asia/Pacific were offset by weaker numbers in EMEA. We’d note that the fiscal Q1 numbers showed sales growth of about 11% as well. Starbucks Corporation (NASDAQ:SBUX) has managed to convert the better revenue numbers into higher earnings: during the first six months of this fiscal year net income has risen 19% from its levels a year ago, with earnings per share of $1.08. The $1.4 billion in cash flow from operations is also a significant increase; Starbucks Corporation (NASDAQ:SBUX) returned most of this cash to shareholders, including through about $590 million in share repurchases.
If we annualize the $1.08 figure, we get a P/E multiple of 31. Even as markets generally assign high multiples to quick service restaurants, this still reflects a considerable premium for Starbucks Corporation (NASDAQ:SBUX) in our view based on its growth rates and on its brand popularity among key demographics. Wall Street analysts expect EPS to rise further in the following fiscal year, to $2.63, which would represent a 21% increase from this year’s levels- in other words, an actual increase in earnings growth from the rates we are currently seeing. That would result in a forward P/E of 25, and frankly it seems like a high bar for the business.
As part of our work researching investment strategies, we track quarterly 13F filings from hundreds of hedge funds and other notable investors; we’ve actually found that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year (learn more about our small cap strategy). We can see from our database that billionaire Steve Cohen’s SAC Capital Advisors had 3.2 million shares of Starbucks Corporation (NASDAQ:SBUX) in its portfolio as of the end of March (see Cohen’s stock picks) while D.E. Shaw, a hedge fund managed by billionaire David Shaw, reported a position of 1.2 million shares (find D.E. Shaw’s favorite stocks).
The closest peers for Starbucks are likely Panera Bread Co (NASDAQ:PNRA) and Dunkin Brands Group Inc (NASDAQ:DNKN). These two stocks also carry premium valuations, and even with the sell-side being optimistic on each’s prospects over the next year their forward P/Es are 23 and 24 respectively (and therefore in line with that of Starbucks).
Dunkin actually hasn’t done too well recently, going by the company’s reports- even revenue growth has been fairly light- and with the valuation highly dependent on improving its earnings going forward it doesn’t seem that interesting to us. Panera recorded double-digit growth rates on both top and bottom lines in its last quarterly report compared to the first quarter of 2012. As it’s a smaller company than Starbucks, we’d generally expect it to have more long-term growth potential and given its similar pricing to that company it seems like at least as good a prospective growth stock.
We can also compare Starbucks Corporation (NASDAQ:SBUX) to McDonald’s Corporation (NYSE:MCD), the market leader in quick service restaurants, and to Chipotle Mexican Grill, Inc. (NYSE:CMG), another high growth company in the segment. McDonalds has been seeing very low growth, though markets somewhat account for that by pricing it at a discount to these other companies: the trailing earnings multiple is 19. That is still too high to qualify for value status, and so even with a decent dividend yield of just above 3% we think that we would avoid it. Chipotle, on the other hand, is even more expensive than the Panera/Dunkin/Starbucks cluster on a forward earnings basis at 29 times consensus forecasts for 2014. Growth numbers continue to be strong, with net income up over 20% in its most recent 10-Q compared to the same period in the previous year; the stock has fallen 4% since a year ago as markets become more skeptical that Chipotle can sustain these high growth rates.
We are, in fact, concerned that Chipotle might not be able to increase its earnings enough over the next several years to justify its current valuation. If there is an interesting growth stock here worthy of further research it would likely be either Starbucks or Panera, given that these companies at least feature something of a discount to Chipotle’s levels but are also characterized by high growth.
Disclosure: I own no shares of any stocks mentioned in this article.
