Will the Economy and Employee Costs Put Pressure on Starbucks Corporation (SBUX)?

Starbucks Corporation (NASDAQ:SBUX) has made a number of acquisitions, which many investors did not anticipate in these uncertain economic times. When a company acquires other companies, the market is usually skeptical and the stock price declines, unless there is proof that the acquisitions are working. Starbucks appears primed to benefit in 2013 and 2014 from its recent acquisitions of Evolution Fresh, La Boulange, and Teavana.

While the integration of these companies is slower than expected, Starbucks Corporation (NASDAQ:SBUX) common stock should benefit from its domestic and international growth, higher sales in the groceries segment, and somewhat beneficial commodity prices in the next few years. However, a prolonged economic downturn and higher costs from the Affordable Care Act and an increase of the minimum wage  recently discussed by President Obama, could be a negative for the stock in the coming months. This article will discuss why Starbucks is likely to weather higher employment costs.

Valuation and fundamentals

Starbucks is a shareholder friendly company with a tremendous cash inflow generation ability. As a result, the company is able to invest in growing the business while at the same time repurchasing shares and paying dividends. For comparison, Chipotle does not return cash to shareholders in the form of dividends or share repurchases and has growth rates comparable to that of Starbucks Corporation (NASDAQ:SBUX). Another competitor that is growing healthily, Panera Bread Co (NASDAQ:PNRA), also does not offer a dividend but has $580 million left under its share repurchase program. It should be noted that Panera’s cash at hand is insufficient to fully execute its share repurchase program.

On the other hand, Starbucks has an annual dividend yield of 1.5% and has 29 million shares (about $1.6 billion at recent stock price) left under its share repurchase plan after repurchasing 8 million shares in the most recent quarter. This indicates that Starbucks shares likely offer a better value. Below is a table comparing some fundamental and valuation measures of Starbucks to that of Chipotle Mexican Grill, Inc. (NYSE:CMG), Panera Bread, and the S&P 500 Index. It is clear that Starbucks valuation falls between Chipotle and Panera Bread. However, its PEG ratio is lower than that of Panera Bread meaning that adjusted for growth, Starbucks common stock is the most attractive one. In addition, Starbucks exposure to commodity price increases is smaller as the company has already entered into contracts for buying coffee through 2014.

Source: Capital IQ, Thomson Reuters, SEC filings, author’s calculations; CFO – Cash flow from operations; EBITDA – Earnings before interest, tax, depreciation, ammortization.

Headwinds from rising employment costs

It seems that from the table above, Panera Bread and Chipotle have about 22 and 26.5 employees per store, respectively, compared to 8.9 for Starbucks. Thus, any increase in healthcare and employment costs is likely to have less negative impact on Starbucks. For all three companies, employees are an important part of their businesses. However, during its most recent conference calls, Starbucks is the company that was most generous in praising its employees (see below.) This is something you don’t see often with other companies outside the quick service restaurant industry.

• Starbucks — “core to Starbucks’ success are our store partners”, “our U.S. partners achieved record levels of productivity”, “To my partners around the world, I say thank you for all you do to bring the Starbucks experience to life”, “our priorities are integrating the company and employees, now our partners”, “and we will rely on the expertise and passionate commitment of the more than 500 channel development partners around the world who continually exceed expectations”, etc.
• Chipotle Mexican Grill — “focus on identifying top performing employees and develop them, and empower them to become the future leaders of our company”.
• Panera — “Just as a reminder currently we offer healthcare coverage to employees who work more than 25 hours versus the mandated 30 hours in the Healthcare Act”.

It is clear that Starbucks is putting a higher emphasis on its employees than both Chipotle and Panera Bread. With the company introducing fresh juice and bakery items on its menu, employees will become even more important and Starbucks will have to count on its workforce even more. In addition, while Chipotle and Panera Bread employees are mostly part time or hourly employees, Starbucks offers benefits to most of its employees. A full list of the benefits of being a Starbucks partner can be found on Starbucks’s web site.

Conclusion

Howard Schultz, the CEO, president and chairman of Starbucks, has been one of the most outspoken critics of the political stalemate in Washington that is threatening the U.S. economy, as seen in this video. Without a doubt, it is in Starbucks’ best interest for the U.S. (as well as the global) economy to improve and return to its full potential. An uncertain economy together with rising healthcare and employment costs are the largest potential headwinds for Starbucks in the next few years.

However, Starbucks already offers most of the benefits required by the Affordable Health Care Act. Also, the company has many levers it can pull to avoid customers from moving to consuming espresso at home. For example, in Germany, where most people drink coffee in the mornings at home, Starbucks offered a reduced price for those that buy coffee early in the morning. And in the U.S., where more people visit Starbucks in the morning, the company often has promotions that encourage customers to visit in the afternoon by offering discounts to those that bring their receipt from the morning. In addition, Starbucks is actively developing loyalty programs that are aimed at reducing customer defections.

Thus, Starbucks should be able to weather headwinds from a stagnant economy and higher employment costs relatively well. If the company’s recent acquisitions are integrated successfully, Starbucks common stock is likely to reward investors regardless of economic and cost pressures.

The article Will the Economy and Employee Costs Put Pressure on Starbucks? originally appeared on Fool.com and is written by Delian Naydenov.

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