Starbucks (NASDAQ:SBUX) currently has a $56 billion market capitalization, but it could be worth $100 billion in the year 2020. That would give investors an 11% annualized rate of return over the next five and a half years. Although everything will have to fall into place to make it happen, such an outstanding return is not out of the question for a company with such huge growth prospects. Here's how Starbucks can pull it off.
1. International growth is just getting started
Two-thirds of Starbucks locations are in the Americas, but two-thirds of new locations open outside of the Americas. In the first two quarters of fiscal 2014, Starbucks opened 383 locations in Asia compared to just 270 in the Americas. Moreover, 76% of Starbucks' locations in Asia are franchised and most of the new locations are franchised as well. This creates extremely profitable growth; last quarter, the China/Asia Pacific segment recorded a 33% operating margin compared to just 22% in the Americas.
Moreover, new Asian locations are incredibly profitable. According to a November 2013 investor presentation, start-up costs for Asian stores are $250,000, first-year sales are $700,000, and the entire Asian portfolio averages a 21% operating margin. If a first-year store has $700,000 in sales and a 21% operating margin, its first-year profit is $147,000. That's an incredible 59% first-year return on a $250,000 investment. If these unit economics hold up, Starbucks can grow quickly and profitably for many more years.
2. Domestic growth not finished yet
Starbucks may be opening most of its new locations abroad, but its U.S. growth has been nearly as impressive. Its U.S. comparable-store sales grew 6% last quarter, which continued the trend of mid-single-digit growth falling just behind its comparable-store sales growth in Asia. This indicates that Starbucks' U.S. growth story is far from over.
Having thoroughly covered the U.S. with locations, Starbucks is now focusing on driving more customers to its stores later in the day. It has accomplished this by expanding its menu to include gourmet sandwiches, handcrafted carbonated beverages, and even hamburgers. It is also promoting a "Starbucks Evenings" concept that allows professionals to wind down with wine and appetizers after a busy day of work. All of these initiatives combine to give Starbucks a long runway for growth in the domestic market.
3. Non-retail channels not fully explored
Starbucks has a lot of untapped potential in the grocery aisle. Although 88% of Starbucks' revenue comes from its retail locations, the company has a large opportunity to expand its grocery and foodservice sales. Sales of coffee and tea K-Cups are driving Starbucks' double-digit growth in the grocery channel. As technology evolves in the at-home brewing market, K-Cup sales may become a larger contributor to the company's overall results.
4. Teavana provides a lottery ticket
The market is understandably focused on evaluating Starbucks' core business: its coffee locations. However, Howard Schultz's proclamation that Starbucks would "do for tea what we did for coffee" gives investors significant upside if the legendary CEO turns out to be right.
Starbucks acquired Teavana, a chain of mall-based tea houses, at the end of 2012 for $620 million. At the end of March 2013 -- the first quarter after its acquisition -- Teavana had 337 locations. Although the company's retail footprint has not grown significantly, Teavana has stayed in the headlines with moves that presage a great future, most recently by announcing a partnership with Oprah. Since the retail tea market is similar to that of coffee, Starbucks can use its retail know-how to make Teavana an important growth driver in the years ahead.
5. $100 billion in 2020 is possible
If Starbucks hits its stride, a $100 billion market capitalization in 2020 is not out of the question. That would mean an 11.11% annualized return for investors who own the stock today. Here's a quick rundown on what it would take to get there.
The stock currently trades near $75 per share, with a market capitalization of roughly $56 billion. It also trades at 23 times the consensus $2.67 earnings per share estimate for fiscal 2014; this translates into $2 billion in predicted earnings for the year.
In 2020, Starbucks' price-to-earnings ratio will likely be lower because its growth prospects will not be as high. If it trades at 17 times earnings in 2020, it needs to generate $5.9 billion in earnings to reach an $100 billion market capitalization. That would require the company to grow earnings at a 19.75% compound annual growth rate from 2015 through 2020 with the assumption that shares outstanding remains the same.
Analysts expect 18.35% earnings-per-share growth for Starbucks from 2014 to 2015. It will be a challenge to grow at 19.75% through 2020 -- and Starbucks will likely come up a bit short. However, given the strong growth generated by its core operations and the enormous potential of Teavana and the non-retail channels, Starbucks could surprise even the most bullish analysts with explosive growth in the years ahead.
Everything has to fall into place for Starbucks to reach a $100 billion market capitalization in 2020. If the company's retail growth remains robust, and if Teavana and grocery sales grow to become meaningful profit contributors, Starbucks could pull it off. However, even if the company comes up a little short, investors could still receive a mid-single-digit annual return on investment -- not bad for a company with a high valuation and even higher growth prospects.