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(B)(N) SBUX Starbucks Incorporated

June 21, 2013

Deal Book. The Street has just told us that there’s so much that we don’t know about Starbucks that had we known it, we would never have bought it at $10 in 2009 and kept it for all this time through $65 yesterday (The Street, June 21, 2013, Starbucks’ High Should Keep You Awake at Night). Please see Exhibit 1 below, Red Line Stock Price (SP) above the Black Line Risk Price (SF) and for no other reason.

And for even more information on the coffee business, please see also our earlier Post for more background on the first appearance of the hedge fund, Highfields Capital Management LP, in the popular coffee business of Tim Hortons which we’ve had to look at again just two days ago because now Scout Capital Management LLC also wants a doughnut, a cup of coffee, and the takeout window. It’s very alarming but we think we’re going to be OK.

Courtesy: Starbucks Corporation

Starbucks, of course, has a current market value of $46 billion, and would be a much bigger deal, and everybody seems to like them as they are, except The Street and some thirty analysts at the Standard & Poor’s Capital IQ who are sitting at another table and have some reservations.

We didn’t know, for example, that Starbucks’ earnings per share (EPS) have grown at the rate of 21.7% a year, on average, since 1999 and every year except 2008, when they dipped to just 15% and then overgrew thereafter. And since Starbucks has kept the shares outstanding fairly constant at 750 million, the earnings must also be growing at that rate, an astounding 22% per year (in round numbers).

Last year the earnings (after tax) were $1.3 billion so we would expect that to increase to maybe $9 billion (7× at that rate of growth) in the next ten years, and that would suggest gross revenues of $90 billion in 2022 if Starbucks can maintain its margins, doesn’t raise prices (which seems unlikely, but the new Far East business is unlikely to pay $5 a cup even by 2022), if inflation is modest, and the current network of 20,000 stores expands to 140,000 in the next ten years, and the company would have, possibly, 1 million employees to serve our coffee, absent new technology or new management.

Moreover, the stock price has kept up with that rate of growth in the last five years, so we might expect a stock price of $455 (7×$65) in 2022, but it’s doubtful that they will also increase the dividend rate to 10% from the current, barely adequate, 1.4%. We’ll have to sell some of our stock to the late comers if we feel the pinch.

Jack & The Beanstalk
We didn’t get all that.

Growth, however, is not the problem and the analysts think that growth will continue at the rate of 19% per year.

The problem is, and we thank The Street for pointing this out, that Starbucks is significantly overvalued now, as it was in 2009 on the same basis, and that the current price to earnings ratio (PE) of 31× will likely need to be reset to 18× to 20×, and that is also the consensus of thirty analysts who are currently following the stock in Standard & Poor’s Capital IQ.

In other words, if Starbucks doesn’t continue to increase its earnings, then the earnings yield of 3.3% currently (1/(P/E) = E/P) is too low for a company of this caliber and, therefore, we should sell it and take profits now.

We didn’t really get all that but our estimate of the downside in the stock price due to the demonstrated volatility is as much as minus ($6) so that we would not be surprised by any price between the current $65 and $60 to $70. Although we can afford the stop/loss at $60, it would still be trading above the current Risk Price (SF) of $45 which has been increasing steadily regardless of the ambient stock prices. Please see Exhibit 1 below.

We can buy the August put at $63 for $2 per share today and sell an opportunistic call – if the analysts are right – at $70 for $0.80 per share, so that for the cost of holding the stock at $65 and the collar at $1.20 per share ($2 less $0.80), we can hold the stock between $63 and $70 for the next several months with no worry. And if we’re sold out above $70, that would be a real surprise.

Exhibit 1: (B)(N) SBUX Starbucks Incorporated – Risk Price Chart

(B)(N) SBUX Starbucks Corporation - June 21, 2013

(B)(N) SBUX Starbucks Corporation – June 21, 2013

Starbucks Corporation purchases and roasts whole bean coffees and sells them, along with fresh, brewed coffees, Italian-style espresso beverages, cold blended beverages, a selection of teas and coffee-related accessories.

(Please Click on the Chart to make it larger if required.)

From the Company: Starbucks Corporation operates as a roaster, marketer, and retailer of specialty coffee worldwide. As of September 30, 2012, the company operated 9,405 company-operated stores and 8,661 licensed stores. Its stores offer regular and decaffeinated coffee beverages, Italian-style espresso beverages, cold blended beverages, iced shaken refreshment beverages, premium Tazo teas, packaged roasted whole bean and ground coffees, Starbucks VIA Ready Brew soluble coffees, Starbucks coffee and Tazo tea K-Cup portion packs, Starbucks Refreshers beverages, juices, and bottled water. The company’s stores also provide various food items, including pastries, prepared breakfast and lunch sandwiches, oatmeal, and salads. In addition, it licenses the rights to produce and distribute Starbucks branded products to The North American Coffee Partnership with the Pepsi-Cola Company, as well as licenses its trademarks through licensed stores, grocery, and national foodservice accounts. The company offers its products under the Starbucks, Tazo tea, Seattle’s Best Coffee, Starbucks VIA Ready Brew, Starbucks Refreshers, Evolution Fresh, La Boulange, and Verismo brand names. Starbucks Corporation was founded in 1985, has 160,000 employees, and is based in Seattle, Washington.

The Price of Risk

The calculated Risk Price (SF) is a provably effective estimate of the “price of risk” which is “the least stock price at which the company is likeable” (Goetze 2006) and “likeability” is determined by the demonstrated factors of “risk aversion” – we want to keep our money and obtain a hopeful return above the rate of inflation – and the properties of portfolios of such stocks. Stock prices that are less than the price of risk can be said to be “bargain prices” but with the risk attached that the company might never get a higher price other than that due to ambient volatility or “surprise”; on the other hand, investors who are willing to pay the “full price” above the price of risk, and buy and hold the stock at those prices, must also be confident, and have reason to believe, that the company will produce those values, absent new information.

Please see our Posts, The Price of Risk, August 2012 and The Nash Equilibrium & Its Stock Price, October 2012, for more information on the theory.

To see what else “risk averse” investing can do for us, please see our recent Posts, The Wall Street Put, April 2013, and earlier Posts such as The Dow Transports, March 2013, or The Risk Adjusted Dow, March 2013, or The Canada Pension Bond, February 2013, and for a more colorful description of investment risk and the application of the “price of risk” to mergers & acquisitions, please see our Post, Bystanders & Collateral Damage, April 2013.

Postscript

We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product

The Perpetual Bond™“
Alpha-smart with 100% Capital Safety and 100% Liquidity”
Guaranteed
With No Fees and No Loads on Capital

For more information on RiskWerk, please follow the Tags or Categories attached to this Letter or simply enter Search for additional references to any term that we have used. Related data may be obtained from us for free in a machine readable format by request to RiskWerk@gmail.com.Disclaimer Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.

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