Shares of Starbucks (SBUX -0.35%) inched up only 6% in 2014. That tiny gain caused many long-term Starbucks investors, including myself, to wonder whether the stock's 270% rally over the past five years has finally ended. Let's take a look at three factors -- the stock's historical valuation, coffee costs, and the Chinese market -- to see where Starbucks stock will head in 2015.
Source: Starbucks.
Premium valuation and appeal
In terms of valuation, Starbucks stock could swing either way. Excluding fiscal 2013, when annual earnings plunged to a loss because of a $2.8 billion litigation charge, Starbucks' trailing P/E bounced between 24 and 30 over the past four years. If we multiply those multiples by the $3.13 mean EPS estimate Morningstar projected, we get a rough price estimate between $75.12 and $93.90.
Excluding 2013, Starbucks' current P/E of 30.7 has hit a four-year high, indicating that the stock could have more downside than upside potential at current prices. Starbucks stock is also trading at a premium to both McDonald's (MCD 0.47%) and Dunkin' Brands (DNKN), which respectively trade at 18 and 30 times trailing earnings.
However, investors should remember that Starbucks is still growing faster than its rivals. Last quarter, Starbucks' revenue rose 10% year over year. By comparison, McDonald's revenue fell 4.6% last quarter and Dunkin's inched up only 3.4%.
Starbucks also has unmatched brand recognition among coffeehouse chains. Starbucks is often as widely recognized as McDonald's, but the former is considered a premium brand in most markets, while the latter is synonymous with cheap fast food. Starbucks hopes that premium appeal will help it move upmarket, as it opens around 100 higher-end "Starbucks Reserve" stores across the world over the next five years.
Coffee costs won't matter ...
As for coffee costs, Starbucks locks in its coffee prices with coffee futures. Doing so protects its bottom line if coffee prices soar the following year, but it can backfire if they unexpectedly decline.
Source: Ragesoss, Wikimedia Commons.
Starbucks has locked in only 60% of its coffee prices for next year. The remaining 40% remains exposed to higher coffee bean prices in 2015. A drought in Brazil, one of the world's top producers of Arabica beans, caused the price of Arabica to soar from 139.5 cents per pound in 2013 to 198.8 cents in 2014.
The good news is that analysts don't expect a huge spike in coffee bean prices next year. According to the EIU Economic and Commodity Forecast, the price for Arabica beans is expected to rise only moderately to 203.3 cents per pound in 2015.
Investors should note that coffee costs accounted for only around 10% of the company's total expenses last year. Moreover, Starbucks has never lowered an annual EPS forecast because of coffee costs.
... but China will matter
Investors shouldn't fret about higher coffee bean costs, but they should worry about China's recent economic woes.
In fiscal 2014, Starbucks' China/Asia Pacific region was its fastest growing one, posting 7% comparable sales growth compared with 6% growth in the Americas and 5% growth in the Europe, Middle East, and Africa region. Last quarter, Starbucks' China/Asia region accounted for 7.4% of its top line and 12.1% of its operating income.
Starbucks plans to open 850 new stores in the China/Asia Pacific region, with two-thirds licensed, or franchised, in fiscal 2015. Last quarter, it opened 199 stores in the region, with 120 locations in China, bringing its Chinese store count to nearly 1,400.
However, Starbucks' growing dependence on China could become a liability if China's economy continues to slow down. According to Bloomberg, China's year-over-year GDP growth came in at 6.78% in November, down from 6.91% in October. This means that China will probably fall short of its full-year GDP growth target of 7.5%. According to the EIU Economic and Commodity Forecast, China's annual GDP growth could contract to 5.9% by 2018.
If the Chinese economy slows down, Starbucks' comparable sales and expansion plans could take a hit. If China's ongoing "mini-stimulus" plans weaken the renminbi, Starbucks' earnings will be reduced by foreign currency impacts when reported in U.S. dollars.
Should Starbucks investors worry?
For now, the one thing I'd keep an eye on is China, which could cut Starbucks deeply if its economy tumbles and the renminbi crashes. Stock valuations will level out over time if the company meets earnings expectations, and coffee bean prices look stable for 2015.
Looking ahead, Starbucks stock might not post the double-digit gains of past years, but I think it could slowly rise if its growth across Asia remains on track and sales across the Americas remain steady.
