In the world of business, providing customers with amazing products and/or services alone can be a recipe for success. But when this is paired with masterful marketing, that success can be taken to a stratospheric level.
Starbucks (SBUX 1.09%) is one of the best examples of a company that has done both of these things. With that in mind, let's dig into the coffee behemoth's fundamentals and valuation to better understand why it is a buy for dividend-growth investors.
Burgeoning loyalty program powers topline growth
Since its founding in 1971, Starbucks has grown from just a single store to more than 35,700 as of Oct. 2. This incredible ascension to become the top coffee chain in the world was the result of two factors.
First, Starbucks secures only the best ingredients from its suppliers. Along with the passion of the company's master roasters and baristas, this has translated into exceptional product quality.
Second, Starbucks has proven itself to be a master marketer. The coffee and cold beverage company believes in providing a relaxing and comfortable experience to its customers in addition to top-notch products, which have garnered it a cult-like following.
Thanks to these two elements, Starbucks has created a wide competitive moat. The company reported $8.4 billion in net revenue for the fourth quarter ended Oct. 2, which is equivalent to 3.3% growth over the year-ago period. And it gets even better: Q4 only had 13 weeks in it instead of 14 weeks as it did in the previous fiscal year. Adjusting for this variable, net revenue would have grown at an 11% clip during the quarter. What was behind the large-cap company's solid net-revenue growth in the quarter?
The coffee giant continued to have success enrolling customers in its Starbucks Rewards program: Membership grew 16% year over year in the U.S. to 28.7 million. Given that Starbucks incentivizes its rewards members to spend more frequently and heavily than non-rewards customers, this is what propelled 11% comparable-store sales growth in the U.S. Strong growth in the U.S. was more than enough to offset a 5% decline in international comparable-store sales. The company's weak showing internationally was due to a 16% plunge in China's comparable-store sales, where the company operates 6,000 of its stores. As many customers were under strict COVID-19 guidelines and unable to leave their homes, this led to a 17% dip in comparable transactions.
Adjusting for one less week for its fourth quarter, Starbucks' non-GAAP (adjusted) diluted earnings per share (EPS) fell 9% over the year-ago period to $0.81. Owing to inflationary pressures, the company's non-GAAP operating margin fell by 290 basis points year over year to 15.1% during the quarter. Even with the 3% reduction in its weighted average diluted share count to less than 1.2 billion, this wasn't enough to offset the reduced profitability. This is why adjusted diluted-EPS growth lagged behind net-revenue growth in the quarter.
As inflationary pressures gradually diminish and Starbucks significantly grows its global store count, profits should soar. This is the rationale behind analysts' 16.5% annual adjusted diluted-EPS growth forecast for the next five years for the leading coffee and cold beverage brand.
Image source: Getty Images.
A future Dividend Aristocrat
Starbucks boasts a 2% dividend yield, which is moderately above the S&P 500 index's 1.6% yield. And the company has raised its dividend for 12 straight years, which puts it on course to become a Dividend Aristocrat by 2035.
My confidence in Starbucks' ability to one day join the ranks of the elite Dividend Aristocrats hinges largely on these aspects: Its robust earnings-growth prospects could support a growing payout to shareholders. And the dividend payout ratio is expected to come in around 62% for the current fiscal year that began in early October. This will give Starbucks the capital that it needs to invest in future store openings and debt reduction to strengthen the business.
Starbucks' stock is still a buy after its rally
Stemming from its rock-solid fundamentals, Starbucks' stock has rocketed 31% higher in the last six months. Yet, the valuation is still more than fair relative to its peers.
Starbucks' forward price-to-earnings (P/E) ratio of 26 is only a tad higher than the restaurant-industry average forward P/E ratio of 25.3. And given that Starbucks' 16.5% annual earnings-growth projection is more than the industry average of 12.9%, the stock arguably deserves its premium valuation. This is why I believe Starbucks is capable of delivering double-digit annual total returns over the next five to 10 years.
