For investors, there's nothing more fulfilling then investing in something you know and then seeing that investment pay off. Starbucks (SBUX +0.59%) is one of the biggest brands in the world, and it's hard to find a town without at least one store these days. Potential investors may know the Starbucks brand, but what about the business underneath? This is an introduction to Starbucks for investors, consumers, and the business-minded in all of us.
Source: Starbucks.
What makes Starbucks tick?
Starbucks is primarily a roaster and seller of coffee. That may seem like basic information, but it hides a few important details. First of all, notice that I didn't say that Starbucks is a grower. The company buys all of its coffee from a wide variety of suppliers and then roasts the coffee for sale to the public. This means that Starbucks isn't in direct control of its entire production chain -- more on this when we get to risks.
Apart from coffee, Starbucks has recently pushed further into food sales in its stores and has begun relaunching the Teavana tea brand, which it acquired last year. All of those -- coffee, food, and tea -- are food service businesses. In addition to that broad section of the business, Starbucks sells packaged coffee in a variety of formats, and it licenses its brand to third-party companies for their goods, as well.
That's the revenue side of the business in a nutshell. In the company's last fiscal year, all of those operations generated $14.9 billion in revenue.
What does Starbucks' balance sheet look like?
Starbucks is in a very strong balance sheet position. The company now has $2.57 billion in cash and cash equivalents on hand. That's offset by only $1.7 billion in long-term debt and other long-term obligations, giving the company plenty of breathing room. The reason Starbucks is in such a strong cash position comes down to its free cash flow generation.
Free cash flow is one way to assess the strength of a business. Instead of just looking at how much Starbucks pulls in or how much it makes in "income," free cash flow gets right to the heart of the matter. How much cash is the company generating? This is a harder metric to fudge, as it doesn't rely on inventories or intangible values that business accountants often flex. Amazon.com CEO Jeff Bezos has said that free cash flow is his main metric for tracking his company's success.
Last year, Starbucks generated $1.7 billion in free cash. That means that the business is bringing in plenty of green to keep it going.
Who competes with Starbucks?
Aside from its own operations, Starbucks is subject to the ups and downs of its competitors. Companies like Panera Bread (PNRA +0.00%), Dunkin' Brands, and Green Mountain Coffee Roasters (GMCR +0.00%) all impact Starbucks with their actions.
To combat these competitors, Starbucks has made a lot of changes over the last year. The company expanded and reworked its food offerings in part to compete with Panera, which has seen strong income growth as more consumers turn to fast-casual dining. That's given Panera a boost on the bottom line -- income was up 17% in the third quarter -- while potentially stripping customers from Starbucks. Starbucks has reacted by increasing its food diversity and quality, which has resulted in a bump in comparable sales.
On the home front, Green Mountain has continued to dominate the single-serve brewing business. The Keurig brewer has about 16 million units installed in the U.S., while Starbucks' corresponding Verismo system seems to have faltered on launch. As evidence, in May 2013 Starbucks announced a new partnership with Green Mountain, in a "If you can't beat 'em, join 'em" move.
What are the risks?
While Starbucks has a strong business model and is growing, it's clear that it can't win all its battles. The biggest long-term issue may be the increasing difficulty of sourcing green coffee. Coffee is a fickle plant, and the best coffee comes from an even more fickle variety. As temperatures increase, the physical land available for growing high-quality coffee is shrinking. Along with the drop in arable land is a spread of disease and fungi that are taking their toll on the future of coffee.
As those pressures increase, coffee prices are likely to see spikes and general increases. That's going to push Starbucks -- and every other coffee company -- to make some big changes. No matter what the result, it's not going to be great. While Starbucks does have competitors, over the long term I'm less concerned about them and more concerned about the availability of the base product.
A good place to start
Balancing the risks and the potential, I still believe that Starbucks is an excellent business for investors. There's a lot of growth in new beverages, geographies, and foods, but even with very little growth, the business can thrive. The main downside to Starbucks is its relatively high valuation. The company's stock currently trades at a trailing price-to-earnings ratio of almost 40. That means that for every dollar the company made in the last 12 months, investors are being asked to pay $40.
With such high expectations, even small bumps in the road can result in large drops in the stock's price. If you're the kind of person who obsesses about daily movements, this can be a stressful stock to own. If you're happy to buy it and put it aside, I think Starbucks makes for a great addition to most portfolios. Obviously everyone's situation is different, but if you're looking for some retail exposure, take a deeper look into Starbucks.
