Rising Star Buy: Starbucks

This article is part of our Rising Star Portfolio series.

Starbucks (Nasdaq: SBUX  ) has experienced its share of troubles in recessionary times, but it still possesses heart and soul. Its positive sense of purpose makes it the latest purchase for my Rising Star portfolio.

The business
Starbucks cafes blanket the American landscape. Since inception, founder and CEO Howard Schultz has worked hard to transform coffee into a special, emotional experience for consumers. Starbucks is a stellar American brand.

Starbucks cafes aim to be comfortable "third places" between home and work. Starbucks also provides Tazo teas and the Seattle's Best brand. In addition to its cafe sales, Starbucks distributes through retailers. The coffee giant has put down stakes in 50 countries. 

Although 2008 was a terrible year for many stocks, Starbucks took some real knocks as its growth slowed and difficult decisions loomed. Management had to admit to sloppy overexpansion and execute painful store closures and layoffs. However, under Schultz's leadership, Starbucks has achieved an outcome that's often very difficult: a swift turnaround.

Starbucks has social responsibility at its core. It has long worked hard at ethical sourcing, having designed the Coffee and Farmer Equity (CAFE) practices. In 2010, 84% of the 269 million pounds of coffee it bought came from CAFE-approved suppliers.

The coffee giant has plenty of environmental strategies, too. It's been testing cup recycling and is on track to meet its goal to provide comprehensive recycling solutions for its paper and plastic cups by 2012. In December 2010, it finished the initial phase for the U.S. Green Building Council's LEED Volume Certification program; its goal is to build all new company-owned stores according to LEED specifications.

Why I'm buying
Unfortunately, Starbucks isn’t trading in the bargain bin like it was in 2008; that was an amazing opportunity to purchase the stock on super sale. Starbucks shares currently trade at 21 times forward earnings and sport a PEG ratio of 1.52. Still, I wouldn't call the stock outrageously priced even if it's not in the beaten-down value stock category.

I'd call rival Green Mountain Coffee Roasters (Nasdaq: GMCR  ) outrageously priced, though, trading at 40 times forward earnings and a PEG ratio of 1.68. Can Green Mountain keep up the growth analysts and investors have come to expect? Furthermore, Green Mountain critics point out questionable accounting methods and lack of quality earnings, which adds a very troubling angle to the investment. I'll pass.

Starbucks' current plan to pursue international expansion more aggressively than ever is a major part of my growth thesis. As of fiscal 2010, international sales represent just 21% of Starbucks' net revenues. There's a major growth opportunity, particularly in Asia.

The coffee giant's vows to delve deeper into China and transform tea drinkers into Starbucks aficionados is a massive market opportunity. It plans to triple its number of Chinese locations by 2015, which would represent a total of 1,500 cafes. China's middle-class population is exploding -- it's expected so surge to four times that of the U.S. in a single generation. This is a huge opportunity for Starbucks, if it can get the temperature just right.

And now, the risks
Starbucks faces steep competition. Take Green Mountain, with its Keurig single-cup coffee machines. (Granted, Green Mountain is a rival-turned-partner now.) 

Other caffeinated competitors include Caribou (Nasdaq: CBOU  ) , which also operates cafes, and consumer giants like Maxwell House purveyor Kraft (NYSE: KFT  ) . Recent IPO Dunkin' Brands (NYSE: DNKN  ) is another major contender; coffee represents 60% of its sales. And who can forget McDonald's (NYSE: MCD  ) and its big push into cheap, fast gourmet coffee?

On a macro level, U.S. unemployment remains high and isn't likely to reverse itself in a meaningful way anytime soon. The eurozone is fraught with economic uncertainty, too. If increasing numbers of consumers cut out extras like gourmet coffee, Starbucks could suffer very much. After all, lattes are easy to excise from daily expenditures.

Last but not least, international expansion is always risky. Can Starbucks create the same enthusiasm for its coffee in Asian markets as it has here? Will cultural and regulatory differences put up too many roadblocks? The rewards could be huge, but we can't ignore the risks.

Foolish bottom line
Schultz's recent memoir, Onward, reminded me of the aspects that first attracted me to Starbucks' stock years ago. (Oh, and by the way, Mr. Schultz, if you're out there reading by any chance, you were right and I was wrong about VIA. Respect!)

Schultz can be placed in the category reserved for great CEOs; for example, he has preserved health-care benefits for workers even when some shareholders exerted pressure to cut that cost.

"As I saw it," Schultz wrote in Onward, "Starbucks had three primary constituencies: partners, customers, and shareholders, in that order, which is not to say that investors are third in order of importance. But to achieve long-term value for shareholders, a company must, in my view, first create value for its employees as well as its customers."

This type of thinking exemplifies the best companies, in my opinion. That’s at the heart of why I'm putting Starbucks into my Rising Star portfolio; Schultz is dedicated to keeping the company's soul.

Alyce Lomax and The Motley Fool own shares of Starbucks. Motley Fool newsletter services have recommended buying shares of Green Mountain Coffee Roasters, McDonald's, and Starbucks and creating a lurking gator position in Green Mountain Coffee Roasters. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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