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Dueling Fools: Starbucks Bull

By Nate Parmelee – Updated Nov 16, 2016 at 12:18PM

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Good businesses are often expensive for a reason.

There's a part of me that doesn't enjoy writing the bull argument for Starbucks (NASDAQ:SBUX). The company is already known so well, and just about everything that can be said about the company already has been. But when Starbucks came up on our list of potential duels, I just couldn't resist signing up to defend the company where growth has become routine.

The numbers don't lie
I'm pretty sure that my Foolish colleague is going to point out that Starbucks is overpriced. Like all good long-term growth stocks, it's just about always overpriced, but it's not as severely overpriced as Google (NASDAQ:GOOG) or any of the highfliers of the dot-com era. And to a certain extent, the company has earned its premium. After all, how many other companies can open up 1,200 stores a year and still wind up with $400 million in free cash flow, the way Starbucks did in 2004?

The free cash flow and consistent same-store sales growth are nice, but there are other reasons to like Starbucks' performance. For a long time, folks were unimpressed that Starbucks hadn't expanded its margins in a material manner, but that's changed in recent years. In 2004 and on a trailing-12-months basis, Starbucks is getting the best margins it has ever seen on the operating and net margin levels. Furthermore, there's reason to believe the company can squeeze out a little bit more than the 7.7% net margins it has registered over the last 12 months (according to data from Capital IQ).

While I would really like to see Starbucks begin to share some of its free cash flow with investors in the form of a dividend, I'm quite pleased with the way the company put its cash to work this year repurchasing shares. Through the last 12 months, the company has repurchased more than $850 million of its shares, and in so doing reduced its share count by about 4%. The bulk of those purchases were made with the shares around $25 (split-adjusted), and given that in the most recent quarter shares were sometimes $24, there is reason to believe that Starbucks will report additional share repurchases when its 10-K annual report is filed about a month from now.

Brand expansion
The most interesting thing about Starbucks is that there really isn't anyone standing in the way of this money-making machine. This will eventually change, of course. But to date, Peet's (NASDAQ:PEET), Caribou Coffee (NASDAQ:CBOU), and Dunkin' Donuts haven't stopped the Starbucks expansion parade. Even in Japan, where there was already a strong coffee culture and established competitors in Doutor, Excelsior, and numerous small cafes (kissaten), Starbucks has flourished.

Starbucks isn't stepping off the gas anytime soon. Through its partnerships with Pepsi (NYSE:PEP) and Dreyer's Grand Ice Cream, the company already had considerable success with products sold outside of its stores. Last year, the company took it a step further by partnering with Fortune Brands (NYSE:FO) to launch a coffee liqueur, which will be followed up this holiday season with a cream liqueur. This year the company also partnered with Suntory (a Pepsi partner) to launch its bottled coffee beverages in Japan.

Foolish final thoughts
For the reasons outlined above, Starbucks has never been a cheap stock, and it's not likely to be cheap anytime soon. Though I find Starbucks' case compelling, I'd be remiss if I felt that today's prices were an unbelievable deal for investors. They're not. However, only two months ago, the shares were at the high end of what I consider to be reasonably priced. A lot can change in two months, and given the natural volatility of markets, a 10% to 15% drop in price is entirely possible and would put shares back into that reasonable price range.

But, wait! You're not done. This is just a quarter of the Duel! Don't miss Rich Smith's bear case, the rebuttal, and Nate's final word. When you're done, you're still not done. You can vote and let us know who you think won this Duel.

Nathan Parmelee owns shares in Starbucks and has for quite some time. He has no financial stake in any of the other companies mentioned. The Motley Fool has an ironclad disclosure policy.

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Stocks Mentioned

Alphabet Inc. Stock Quote
Alphabet Inc.
GOOGL
$98.74 (-1.40%) $-1.40
Starbucks Corporation Stock Quote
Starbucks Corporation
SBUX
$84.17 (-0.63%) $0.53
Pepsico, Inc. Stock Quote
Pepsico, Inc.
PEP
$168.52 (-0.05%) $0.08

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