Stock Rating

Industry View Price Target

Market Cap (USD) Shares Outstanding (mm) Dividend Yield (%) Average Daily Volume (mm) Return on Equity TTM (%) Source: Yahoo! Finance

Price Performance 52 Week range

Equity Research

Consumer Discretionary Sector

15 January 2019

Rating here

POSITIVE

$79.32

Price (1/15/2019) Potential Upside/Downside

$64.08 +23.8%

80.06B 1394.6

2.23 13.27

136.23

Exchange—NASDAQ $47.37—$68.98

Consumer Discretionary Thomas Babiak me@tombabiak.org Senior Analyst

Starbucks Corporation

Strong International, Domestic Growth will Drive Revenues

We initiate coverage on Starbucks Corporation (NASDAQ: SBUX) with a BUY rating. We believe that Starbucks shows (and will continue to show) potential in 3 key areas: • Domestic growth as the US economy (and consumer spending, disposable

income, and confidence) continues to grow at a healthy rate • International growth, especially in China, as the middle class continues to

expand rapidly and consumers desire a taste of foreign goods • The channel development segment, with its high operating margins, as

consumers want to bring the taste and experience of Starbucks to their homes and offices

SBUX: Financial and Valuation Metrics

(Last Four Quarters) 2018 Q1 2018 Q2 2018 Q3 2018 Q4 2019E

EPS ($) 0.65 0.53 0.62 0.62 2.64

Consensus EPS ($) 0.57 0.53 0.60 0.59 -

Next Earnings Date: January 24, 2019

Figure 1: Starbucks stock TTM performance

Rutgers Student Managed Fund | Starbucks Corporation

2 March 2019 1

Industry Overview Consumer Discretionary Consumer Confidence In December 2018, employers added 312,000 jobs to nonfarm payrolls in the US labor market, and the unemployment rate remains below 4% as more workers enter the labor force. Average hourly earnings rose 3.2% in 2018, the largest yearly gain of the current expansion. The Consumer Confidence Index remains high, at 128.1 in December 2018 (although it declined from its November high). This strong earnings growth appears to have given consumers confidence about the future, since retail sales are predicted to grow by at least 4% in 2019 according to Kiplinger. An increase in wage growth and future outlook means that consumers are willing to spend more on everything from big-ticket items to everyday purchase; they are more willing to sacrifice higher marginal costs for a higher “premium” factor. Restaurants and Entertainment Industry Trends 2018 represented the ninth consecutive year of sales growth in the food service industry, according to the National Restaurant Association. Sales grew to $825 billion that year, representing a 4% nominal growth rate. Coffee shops specifically reached sales of $23.4 billion in 2017, representing 41% growth from 2011. Innovation in this segment of the industry has driven sales growth, as new types of coffee beverages gain popularity (sales of cold brew, for example, grew 460% between 2015-2017) and shops strive to deliver a unique and ‘premium’ experience.

Philosophy Starbucks, based in the United States, is the largest coffee retailer in the world by revenue and commands almost twice as much US market share as the runner-up. The company is a roaster and retailer of coffee, with an emphasis on premium products and creating a community meeting place at their locations. Starbucks also offers an assortment of pastries, snacks, and fresh food, as well as coffee accessories and merchandise at its company owned and licensed locations. Starbucks focuses on delivering its products and services ethically, sustainably, and responsibly, as well as making a global impact. International Presence Starbucks operates through four segments globally: Americas (Latin America, Canada, United States); China/Asia-Pacific; Europe, Middle East, and Africa; and Channel Development. Brand positioning and image Starbucks strives to make itself a part of every customer’s daily routine. Coffee is made to customers’ specifications, with their name written on the side of the cup. Brand loyalty is encouraged through Starbucks Gold Cards that reward routine purchases. Starbucks positions itself as a premium coffee brand with the likes of Kuerig and Pret a Manger as opposed to the value-oriented offerings of Dunkin’ Donuts. In this way, Starbucks allows the typical middle class individual to live a ‘premium’ lifestyle through coffee.

Business Overview

Figure 3: Starbucks logo

Figure 4: The typical interior of a Starbucks location

Figure 2: Consumer Confidence Index for the past two decades

FIGURE 5 Operating Income and Margins (% YoY) I project a stabilizing operating margin at around 18%. Operating income is also projected to grow at a healthy rate Y/Y due to aforementioned factors. Dollar values in millions.

Rutgers Student Managed Fund | Starbucks Corporation

2 March 2019 2

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

$-

$1,000.0

$2,000.0

$3,000.0

$4,000.0

$5,000.0

$6,000.0

$7,000.0

2016 2017 2018 2019 2020 2021 2022 2023

Hist. Hist. Hist. Proj. Proj. Proj. Proj. Proj.

Year

Starbucks Operating Income and Margin

Operating Income Operating Margin

$-

$5,000.0

$10,000.0

$15,000.0

$20,000.0

$25,000.0

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

Hist. Hist. Hist. Hist. Hist. Proj. Proj. Proj. Proj. Proj.

Year

Starbucks Company Operated and Licensed Stores and Revenue (Americas Segment)

Revenue generated (company operated) Revenue generated (licensed)

Company-operated stores Licensed Stores

FIGURE 6 Number of Company Operated and Licensed Stores as well as revenue for each (Americas Segment) The Americas segment continues to grow at a fast pace, due in large part to the strength of the US economy. Licensed stores continue to grow, promoting brand exposure as well as allowing for future revenue per store growth. Dollar values in millions.

FIGURE 7 Number of Company Operated and Licensed Stores as well as revenue for each (CAP Segment) The China/Asia Pacific segment has grown at an incredible rate and shows great promise for the future for factors mentioned earlier in this report. The stronger growth of company-operated stores over licensed stores will also ensure that Starbucks can have a secure foothold in the region irrespective of geopolitical tensions. Dollar values in millions.

Rutgers Student Managed Fund | Starbucks Corporation

2 March 2019 3

$-

$1,000.0

$2,000.0

$3,000.0

$4,000.0

$5,000.0

$6,000.0

$7,000.0

$8,000.0

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

Hist. Hist. Hist. Hist. Hist. Proj. Proj. Proj. Proj. Proj.

Year

Starbucks Company Operated and Licensed Stores and revenue (CAP Segment)

Revenue generated (commpany operated) Revenue generated (licensed)

Company-operated stores Licensed Stores

Dunkin’ Brands specializes in cheap and convenient coffee and breakfast foods. The company operates primarily as a franchise, a structure that has allowed it to expand its brand reach greatly. The chain has over 11,300 locations globally, with 8,500 in the United States (mostly concentrated in the Atlantic Northeast). In 2017, the company generated $861 million in revenue, which represented 3.8% growth Y/Y. Nearly $600 million of this revenue comes from franchise fees and royalty income, with another $100 million coming from rental income. Dunkin’ Brands is Starbucks Corporation’s largest competitor in the coffee space, offering a low-cost and no-frills experience that contrasts with the more premium offerings at Starbucks. McDonald’s Corporation is a leader in the fast-food industry. The Corporation generates approximately half of its revenue from company operated stores, while the other half comes from franchised restaurants. McDonald’s serves local cuisine in its international segments, as well as coffee and other beverages. The company sells breakfast foods and beverages through its McCafe line of products, which competes with Starbucks. In 2018, the company generated $21.20 billion in revenue, representing a 9.81% decline Y/Y. The company faces headwinds as consumers become more health conscious and therefore avoidant to brands with a connotation of unhealthiness such as McDonalds. Aramark provides food, facility management, and uniform services to various industries globally. The company specializes in food and support services, which encompasses everything from food service management, facility maintenance, supply chain management, construction management, to catering. Through its food division, the company provides concessions and catering on campuses worldwide, and also offers coffee and grab and go foods. Although not competing with Starbucks directly, Aramark is a low-cost alternative for general food solutions for larger clients, an area that Starbucks may expand into in the future. In 2018, Aramark generated $15.79 billion in revenue, representing an 8.12% increase Y/Y. Yum! Brands, Inc. operates more than 43,500 KFC, Pizza Hut, and Taco Bell franchise locations in more than 135 countries worldwide. These segments serve various chicken, pizza, and Mexican-style food products, respectively. Each of these segments adapt their menus to the local cuisine as needed. Of these, only Taco Bell has fully launched a breakfast product lineup. However, given that Yum! Brands still operates within the food industry, they are a competitor for Starbucks. In 2018, Yum! Brands, Inc. generated $5.71 billion in revenue, representing a 9.77% decline Y/Y. Of this revenue, $3.5 billion came from company sales and $2.3 billion came from franchise and license fees. Chipotle Mexican Grill, Inc. specializes in serving Mexican-style individually prepared meals in its 2,198 company operated restaurants. This includes a variety of burritos, tacos, and burrito bowls that customers create down a serving line (adding toppings as they please). The company prides itself on using non-GMO ingredients and on not using preservatives, artificial flavors, or artificial colors. Although Chipotle does not serve coffee in most of its restaurants, it competes with Starbucks in the “premium fast food” space. In 2018, the company brought in $4.75 billion in revenue, representing a 7.93% increase Y/Y.

Peer Comparison

Rutgers Student Managed Fund | Starbucks Corporation

2 March 2019 4

Comparable Company Analysis Summary P/E EV/EBITDA EV/Revenue

(data from 1/16/2019) Price ($) Shares (mm) Mkt Cap ($bn) EV ($bn) TTM Forward TTM TTM

Company

Starbucks Corporation 64.08 1394.6 80.06 79.63 19.68x 21.12x 15.56x 3.22x

Dunkin' Brands 67.02 82.60 5.54 8.38 14.93x 22.41x 17.01x 9.29x

McDonalds Corporation 179.35 770.91 138.26 169.94 24.67x 14.02x 16.98x 1.97x

Yum! Brands, Inc. 89.83 312.30 28.05 37.88 18.33x 23.64x 20.43x 6.64x

Chipotle Mexican Grill, Inc. 514.82 27.79 14.31 13.42 76.62x 43.05x 24.49x 2.82x

Aramark 31.00 247.38 7.67 14.73 13.84x 11.57x 10.40x 0.93x

Mean 28.01x 22.64x 17.48x 4.15x

Median 19.01x 21.77x 17.00x 3.02x

Min 13.84x 11.57x 10.40x 0.93x

Max 76.62x 43.05x 24.49x 9.29x

Figure 8: A comparison of companies comparable to Starbucks Corp.

Investment Overview

Rutgers Student Managed Fund | Starbucks Corporation

2 March 2019 5

Domestic Growth Potential Licensed Stores Over the last five years, licensed Starbucks stores in the US have been growing at over 5% annually, and I project that by 2023 they will surpass company operated stores in number. Of course, licensed stores are usually small in size physically (usually embodied by a kiosk or small section of a larger bookstore, supermarket, etc.) and thus generate a small share of revenue. Starbucks does not franchise, but instead offers these licenses as a way to expand its brand to more locations with these smaller shops. Of course, after expanding with these satellite locations rapidly, Starbucks could gradually renegotiate the licensing terms to generate more revenue. Additionally, the growth of these locations increases brand awareness as people may become customers after purchasing coffee from these locations. Premium brand success and growth Starbucks is at its core a premium coffee brand, and these companies have done exceedingly well during the booming economic recovery. Being a Starbucks “regular” signals that one can not only afford to pay the premium, but also appreciates a more refined coffee. Some examples of successful premium brands are Canada Goose (winter jackets), Apple (consumer electronics), Lacoste (clothing), and Ray-Ban (sunglasses). Whether or not some of these brands are truly “premium” (in quality, craftsmanship, etc.) is not important; like Starbucks, they have positioned themselves as a high-end product, and this is a trend that consumers have taken to recently. Starbucks has further capitalized on its premium branding by creating “Starbucks Reserve” locations that promise a more sophisticated atmosphere. International Growth China The China/Asia-Pacific segment is showing incredible growth, as revenues grew 38% Y/Y in 2018. Starbucks has also said that it is planning to open nearly 3,000 more stores in the region over the next 3 years. This expansion into the world’s second largest economy will provide an incredible source of revenue as China’s middle class grows and matures. Consumers there will no doubt be looking for ways to use their newfound wealth (from economic growth), and Starbucks provides an affordable way to feel richer (premium coffee). With China’s GDP growing at a consistently high rate (over 6% annually), there seems to be limitless potential in this market. India, Channel Development, and Europe/EMEA Starbucks’ partnership with Tata Global Beverages will allow it to open many more locations in India, a region that, like China, is experiencing enormous economic growth. In the European region, operating income grew the most (as a percentage) out of all of Starbucks’ reportable segments. Coffee shops here are adapted to the region, and if the company can harness the desire for artisan coffee while avoiding a big-brand image, there is much potential for success. Finally, the Channel Development segment, which features products like ready-to-drink beverages, Tazo teas, Starbucks coffee beans, and other branded products. The segment boasts the best operating margin when compared to Americas, CAP, and EMEA, coming in at 37.8%. Although currently the segment only comprises about 9% of Starbucks revenues, it has enormous potential as customers increasingly want to bring Starbucks to their homes and on the go.

Figure 10: A joint Starbucks/Tata location in India.

Figure 9: An example of a Starbucks Reserve location.

Macroeconomic risks Recession/slowdown effects Operating squarely in the premium space of the consumer discretionary sector, Starbucks would be especially affected in an economic slowdown or recession. Given that wages and employment would decrease, consumers would begin cutting costs. Discretionary spending on goods would decrease, especially those with less expensive substitutes (in this case coffee made at home or a different brand like Dunkin’). Consumers would likely be less willing to pay more for the marginal increase in quality at Starbucks during hard times. Additionally, consumer spending on food overall has been slowly but surely decreasing over the last decade; although half of this spending goes to restaurants, this trend does not bode well for long term growth. International relations and trade Operating more than 24,000 stores in over 75 markets and sourcing beans from a plethora of countries, Starbucks is exposed to international affairs. In 2018, the number of international locations eclipsed the number of U.S. locations for the first time. Its second largest market is in China, which is the home of 3,521 coffeehouses. Paradoxically, although the company has become more global over the years, its affiliation with the U.S. and Western culture remains strong. This puts Starbucks at risk of a sharp decrease in store traffic (and therefore sales) should the United States be viewed negatively on the world stage. That is, the success of the Starbucks brand overseas is tied to the perception of the ‘American’ brand. Another (albeit less worrying) risk is a breakdown in global coffee supply chains due to trade conflicts. Currently, the U.S. is embroiled in a trade conflict with China and Mexico, among others. Should the United States turn its attention to the coffee producing nations of the world (Brazil, Vietnam, Colombia) and spawn a trade conflict, Starbucks margins would likely be impacted. Domestic risks Wage increases In the US market especially, Starbucks (like most large companies) faces pressure to increase wages and employee benefits. Starbucks already provides generous compensation to retail employees, which has been instrumental in reducing worker turnover and providing a consistent customer experience. This package includes healthcare/insurance subsidies, stock grants, and schedule flexibility. However, regulation of hourly wages by states and the federal government (a recent trend) may further increase Starbucks’s cost of labor. Political pressures and public positions Recently, many companies in the public eye have taken positions on controversial issues through statements, advertisements, or speeches by chief executives. Starbucks has also at least partially adopted this strategy, publicly declaring its support for same-sex marriage in 2012, and more recently released a statement in January 2017 affirming its support of DACA, the Affordable Care Act, supporting refugees, and its opposition of the border wall proposed by U.S. President Donald Trump. In the modern politically charged sociocultural climate, such virtue signaling can be dangerous, since the company risks both alienating current customers and angering potential customers who disagree with the company’s beliefs.

Investment Risks

Rutgers Student Managed Fund | Starbucks Corporation

2 March 2019 6

Figure 13: An example of Starbucks advertising its political views.

Figure 12: Growth rate in private sector wages.

Figure 11: Specialty coffee consumption in the US over time. Note the drop following the 2008 recession.

Selected Items from Model

Rutgers Student Managed Fund | Starbucks Corporation

2 March 2019 7

Figure 14: Projected income statement and revenue buildout by region.

Selected Items from Model

Rutgers Student Managed Fund | Starbucks Corporation

2 March 2019 8

Figure 15: Final Discounted Cash Flow model.