We are leading [Starbucks] to try to redefine the role and responsibility of a public company.
-- Howard Schultz, former Starbucks Chairman and CEO
The Seattle-based coffeehouse chain single-handedly changed the way North Americans think about a great cup of coffee -- but Starbucks (SBUX -1.09%) has never been simply another place to get great coffee. From the outset, visionary leader Howard Schultz wanted to create an atmosphere for people to meet -- a third place other than home and work. Schultz emphasized employees' (now called partners) welfare, training, and benefits, as he considered them to be ambassadors for the company. Starbucks is committed to fair trade and is widely considered an ESG (environmental, social, and governance) investment.
Schultz first joined the company in 1982 and while traveling in Italy was struck by the numbers of coffee bars and how people would meet and socialize in them. He persuaded the directors to open a coffeehouse in Seattle, which became wildly successful. Starbucks was a roastery that sold packaged coffee before Schultz persuaded the directors to open a coffee shop. But in 1985, he left to form his own coffee chain, Il Giornale. Just two years later, he purchased Starbucks and merged the two companies.
From that single coffeehouse in 1984, Starbucks has grown to more than 30,000 stores, 400,000 employees, and annual sales of $26 billion. Starbucks uses a blended model in which it owns many of its stores and also licenses stores. Today, Starbucks serves more than 100 million customer occasions each week.
In May, the company issued a $1 billion sustainability bond following two previous sustainability bonds issued in 2016 and 2017. The bonds support coffee farmers and greener retail, as the company has a target to have 10,000 greener stores by 2025. Interestingly, the Greener Store Framework was developed in partnership with the World Wildlife Fund (WWF). Starbucks' CFO Patrick Grismer said, "The bond demonstrates Starbucks' commitment to meaningful, continual progress toward our aspiration of sustainable coffee, served sustainably." Grismer said Starbucks' leadership in social and environmental responsibility "is a defining element of who we are as a company."
Starbucks is on the Dow Jones Sustainability Index, is rated No. 14 and the highest retailer on the Drucker Institute holistic company ranking, and is No. 5 on Fortune's World's Most Admired Companies. It's included in many other ESG-related lists, including Barron's 100 Most Sustainable U.S. Companies, Forbes' America's Best Large Employers, and Sustainalytics' Global Sustainability Index, as well as ranking on Ethisphere's World's Most Ethical Companies list for 12 years in a row.
Starbucks possesses many positive qualities on The Motley Fool's ESG Checklist, but to get a better understanding of what makes the coffee chain a high-ESG stock, let's analyze the company using The Motley Fool's 10-question framework for ESG Compounders.
1. Does the company treat its employees, customers, community, and other stakeholders well?
Yes. The company has a 3.8 (out of 5) U.S. employee rating on Glassdoor -- not too shabby but not enough to make it into the top 100 employers on Glassdoor. In fact, 76% of employees approve of CEO Kevin Johnson, and 74% would recommend the company to a friend.
Starbucks was one of the first companies in the U.S. to offer health benefits to part-time workers and currently pays 70% of premium costs and 100% of preventative-care costs. It always refers to its employees as partners and offers opportunities that few employers emulate. In 2014, it set up the Starbucks College Achievement Plan (SCAP), an online bachelor's degree program through Arizona State University with full tuition coverage for partners who work 20 hours a week or more. So far, 2,900 partners have graduated, and 12,000 are currently participating. The company benefits from this program; almost 20% of people applying to Starbucks said SCAP is the driving reason they applied. Partners in the program stay about 50% longer and are promoted at three times the normal rate.
The company is committed to excellence in training partners. In 2012, it held a global leadership conference for 10,000 store managers and regional leaders. This month, it repeated the event for 12,000 partners. At the conference, the company announced it will enhance its mental health initiatives with input from mental health experts and partners. Store managers will be trained in mental health first aid, which teaches laypeople how to help someone with mental illness. This initiative enhances the employee assistance program, which provides short-term counseling. By January 2020, partners in the U.S. and Canada will have access to subscriptions to Headspace, a guided meditation app.
Areas for improvement: Starbucks could improve the barista experience by addressing worker complaints listed on Glassdoor reviews. It would be a better experience for workers if Starbucks allowed more breaks, more vacation, and more reasonable working hours.
2. Is the company a good steward of the environment?
Yes. This is a qualified yes for a company that is so reliant on single-use packaging to sell its goods. However, Starbucks does try to reduce its impact on the environment in numerous ways. Since 1985, it has offered a discount of 10 cents per cup to customers who bring their own reusable cup. It has also developed a recyclable lid that will replace a billion plastic straws per year, and the company is committed to achieving that by 2020. The company is making efforts to find next-generation recyclable or compostable cups via the NextGen Cup Consortium and Challenge.
At the recent leadership conference, Johnson announced that the company plans to operate 10,000 green stores by 2025. Johnson said that "one of our social impact pillars is sustainability." For the past decade, Starbucks has worked with the U.S. Green Building Council on the Leadership in Energy and Environmental Design (LEED) for retail and currently operates more than 1,500 LEED-certified stores. The new initiative will go beyond LEED, with the focus on powering U.S. and Canada stores with 100% renewable energy, using technology that is estimated to save 25% to 30% on energy and water use. The initiative will be developed in partnership with leading experts including SCS Global Services and WWF.
Investing in renewable energy is not new for Starbucks. In 2004, it took the first inventory of its own greenhouse gas emissions and found that 70% came from the purchase of electricity to power stores. By 2015, it had achieved its goal of powering company-operated stores 100% from renewable energy. Also in 2015, it signed on to RE100 and committed to source 100% renewable energy for all global stores, supply chains, and headquarters. According to the Environmental Protection Agency, Starbucks is the ninth-largest user of renewable energy in the U.S.
Areas for improvement: Starbucks could go further by developing an easily and fully recyclable or compostable cup.
3. Does the company promote diversity and inclusion?
Yes. The company is committed to gender and racial pay equity, inclusion, and equal opportunity for all partners. It is equally committed to employing veterans (25,000 veterans and military spouses) and is proud to champion equal rights for people who identify as LGBTQ. Customers who want a reusable cup can even buy a Starbucks-branded Pride Cup.
The company scores 100% on the Human Rights Campaign Corporate Equality Index. After a widely reported event in April 2018, Starbucks closed 8,000 U.S. stores to conduct anti-bias training for 175,000 partners. The catalyst for the companywide training was that two young African American entrepreneurs were waiting to conduct a business meeting in a Philadelphia store, the manager called the police, and they were taken away in handcuffs. The two people were in the store less than 10 minutes and had not yet ordered. The unfortunate event should never have happened, but the company's response demonstrated seriousness and urgency.
Its commitment to veterans and military spouses goes further than the impressive employment numbers. The company is committed to hiring 5,000 more each year and has held 500 hiring fairs in the U.S. to help transitioning veterans and military spouses. They are guaranteed 80 hours of military service pay when called away for National Guard or Reserve duty. By 2022, the company will have 132 stores in military communities, and it also donates millions of cups of coffee to deployed units around the world.
Of the 46 people listed on the company's leadership page, 19 are women, including Chief Operating Officer Rosalind Brewer, who is African American. Five of the 13 members of the board of directors are women.
Areas for improvement: The company should have clearer and less ambiguous policies on when to call 911.
4. Does the company have ethical corporate governance principles?
Yes. The board of directors has an independent chair and vice chair who have the responsibility to communicate to the CEO between board meetings. It is a strong board and notably includes Microsoft CEO Satya Nadella and other impressive executives. Importantly, 10 of its directors are independent. The company has corporate governance principles for the board as well as a code of ethics for senior executives. From the corporate governance principles:
The Board believes that strong corporate governance should include year-round engagement with our shareholders with a focus on creating long-term, sustainable value and having high regard for the interests of all stakeholders.
Board members must hold shares in the company and may only hold one other directorship of a publicly traded company.
The company's Starbucks Standards of Business Conduct focuses on ethics and compliance:
As a global company, we are subject to the highest standards of ethical conduct and behavior. The Standards of Business Conduct help us make decisions in our daily work and demonstrate that we take our legal and ethical responsibilities seriously.
These standards support the company's mission and values, which are well worth reading for any company seeking to emulate Starbucks' ethical leadership.
Mission: To inspire and nurture the human spirit -- one person, one cup and one neighborhood at a time.
Values: With our partners, our coffee and our customers at our core, we live these values:
- Creating a culture of warmth and belonging, where everyone is welcome.
- Acting with courage, challenging the status quo and finding new ways to grow our company and each other.
- Being present, connecting with transparency, dignity and respect.
- Delivering our very best in all we do, holding ourselves accountable for results.
- We are performance driven, through the lens of humanity.
5. Do the company's business model and its investment principles promote ESG principles?
Yes. There is no doubt Starbucks has invested with the environment and social responsibility in mind for a long time. We've already mentioned several initiatives: greener stores, 100% renewable energy, care for and investment in its coffee farmers and their communities, and the sustainability bond.
The company has a strong link with the communities in which its stores operate. In 2016, the company partnered with Feeding America to form the Starbucks FoodShare program, which packaged eligible unsold food items every evening and delivered the food to local nonprofits around the U.S. To date, 20 million meals have been donated through the program. The Starbucks Foundation supports organizations working to create job and education opportunities for young people. It also encourages stores and partners to participate in service projects -- completing 78,000 hours in 2018 alone.
6. Does the company have a healthy balance sheet?
Yes. The company has $4.8 billion in cash and cash equivalents against $11.2 billion in debt, as well as a BBB+ credit rating from S&P Global. Its debt load seems rather high, but management gets a pat on the back for great capital allocation. Two years ago, its debt was at $3.9 billion and cash at $3 billion, a much more attractive balance. The extra debt was used to buy back a boatload of shares while they were relatively cheap and below our estimate of fair value. That's a great deal for shareholders.
In those two years, the diluted share count was reduced by 16.6%. We do not expect that debt to be reduced, because in 2018, the company decided to use more leverage. But neither do we expect it to increase, as the company has said it will resume normal and lower share repurchases after pulling forward $2 billion of 2020 repurchases into 2019 to take advantage of lower prices. That makes sense, as shares now trade close to our estimate of fair value.
7. Can the company generate organic revenue growth supported by long-term tailwinds?
Yes. The company has set long-term targets of 7% to 9% revenue, 8% to 10% operational income, and more than 10% EPS growth. That is all organic, without acquisitions. The biggest revenue growth driver is its new store openings. The company has more than 30,000 stores worldwide and is opening 2,000 net new stores this fiscal year -- approximately 600 in the Americas (mostly U.S.) and 600 in China. The China store base grew 16% year over year to 3,900, and the company continues to open new stores at a rate exceeding one store per day. We expect new store growth to continue at these levels for at least five years. The flagship Starbucks Roasteries and Reserve stores serve to enhance the aspirational impact of the brand and add a halo effect to all stores. Reserve coffees are available in many regular stores.
Same-store sales will add 3% to 4% to revenue growth, which is driven by pricing power, new food and beverage items, and digital engagement with customers. The Starbucks Rewards program and mobile order and pay drove 2% of the recent quarter's same-store sales increase in the U.S.. Rewards members active in the past 90 days total 17.2 million, up 14% year over year. This is highly important, as rewards members accounted for 42% of U.S. tender. China has 9.1 million active rewards members, up 36% from last year and 10% from the previous quarter.
According to eMarketer, Starbucks has the most widely used payments app in the U.S., with 23.4 million users, and is ahead of Apple Pay and Google Pay. It is truly impressive that a coffeehouse chain has the most successful mobile payment app in the U.S. This demonstrates Starbucks' commitment to investing in digital innovation to deepen its relationship with its customers.
Starbucks' partnership with restaurant tech company Brightloom will enhance Starbucks' already impressive digital flywheel. This is a key advantage, as digital engagement with customers drives increased sales. Starbucks' digital initiatives are no surprise, since Johnson was previously with Microsoft (MSFT -0.18%) for 16 years and was CEO of Juniper Networks (JNPR 1.26%) for five years before joining Starbucks in 2009.
Starbucks Delivers is another growth driver in both countries. In the U.S., the delivery partner is Uber Eats, and in China, it's Alibaba. Starbucks' partnership with Nestle (NSRGY -0.45%) through its Global Coffee Alliance positions it to become a major player in consumer packaged goods.
8. Can the business generate growing FCF and sustain high ROIC?
Yes. Over the last five years to September 2018, the company produced cash from operations (net of litigation accruals and unearned income as we are looking at cash-generating ability) averaging around $4 billion per year and increasing significantly over that time. Capital expenditures averaged $1.48 billion, acquisitions $319 million, and divestitures $153 million for net free cash flow averaging around $2.35 million. Free cash flow is variable from year to year, but the long-term trend is upward and driven by increased revenues and increased operational margins.
ROIC has decreased somewhat over the last three years, but it's still high and should remain high in the future, because Starbucks has a wide moat, and ROIC is a factor in management compensation.
9. Is the management team focused on driving long-term profitable growth?
Yes. Every presentation given by Schultz and Johnson speaks to the long-term growth and the social and environmental impact of the business. The pay structure incentivizes long-term performance -- although it is truly more medium-term, but at least there's a high degree of variable pay.
The long term is 71% of total possible compensation and is 60% dependent on achieving two-year EPS targets -- but can be modified downward if ROIC targets are not maintained. The remaining 40% is based on share price appreciation. These stipulations are average and not particularly long term, but it's positive that ROIC plays a part.
10. Does the company have a medium- or low-risk profile?
Yes. Starbucks is classified between medium and medium-low on the risk scale. It has a competitive moat based on its global scale, its ubiquitous brand, its digital connection with customers, and a focus on ESG and the success of all stakeholders. Starbucks has become part of the daily routine of millions of people around the world -- remember, it serves 100 million customer occasions each and every week!
The company faces strong competition from Dunkin' Donuts (DNKN), McDonald's (MCD -0.79%), privately held JAB Holding (which owns several brands including Peet's Coffee, Keurig Green Mountain, and Panera Bread), and myriad smaller specialty coffee chains.
There are few barriers to entry, but Starbucks' position as a premium brand attracts more affluent customers and gives it ample pricing power. During a recession, consumer discretionary spending is reduced, and Starbucks is likely to temporarily lose some business to cheaper alternatives, including folks brewing coffee at home. Aggressive expansion overseas exposes the company to political and economic risks, and expansion into other food and beverage brands (such as Teavana and Princi) brings execution risk.
A perfect 10
In our book, Starbucks scores a perfect 10 if you are looking for an ESG company for the long term. Currently, shares are trading close to our estimate of their value, but as Warren Buffett said, "It's far better to buy a wonderful company at a fair price, than a fair company at a wonderful price."
For another company that scored a perfect 10 out of 10 on The Motley Fool's ESG Checklist, read about Accenture.