Back in March when Howard Schultz, CEO of Starbucks (NASDAQ:SBUX), stated that the company was just getting started with a $100 billion market cap, I immediately wondered if perhaps he had one espresso too many. Here is a company that had its IPO on a split-adjusted basis of $0.53 per share and trades for more than 150 times that (including dividends). Surely it has saturated the market already, right? A closer look under the barista reveals that Schultz may be right and more.
This is not the first time my knee-jerk reaction to Starbucks was that it just had to be mature by now. Rewind back exactly a decade ago, and here is an article claiming that Starbucks was just getting started. I scoffed then, but the author was obviously right.
Then: Starbucks had 6,458 locations.
Now: Starbucks has 20,519 locations.
Then: Starbucks targeted $4 billion in sales for 2004.
Now: Starbucks is targeting $16.4 billion for 2014.
In an interview with Fortune magazine at the time, Schultz stated, "Those who talk about saturation obviously don't understand our business strategy." We understand now with the benefit of 20-20 hindsight, Mr. Schultz. Perhaps we (or I anyway) shouldn't be so quick to doubt you again.
Monetizing the traffic
First, I would argue that Starbucks is almost like Facebook in a sense (bear with me). Recall a few years back many acknowledged Facebook's massive traffic but wondered if the company could make any decent money off of it. The traffic was already there. The trick was learning how to monetize it.
Perhaps Starbucks is the same way. We already know about its popularity for drinks, but the average check size is still tiny. With all that traffic coming through Starbucks' doors already from an absolutely hooked, cult-like following, the next natural step -- like Facebook -- is figuring out how to monetize this traffic.
And Starbucks is doing just that. Last quarter, for example, in the United States, of the 6% increase in same-store sales growth, 3% came from the average ticket size. The No. 1 driver of this was food sales, which now account for 20% of Starbucks' sales.
Starbucks keeps finding innovative ways to tempt our stomachs for something more solid, and it has plenty of available hours beyond the morning for which to potentially lure new traffic. It should come as no surprise, then, that it has racked up 17 straight quarters of 5% or better same-store sales growth.
Overhead and China
In a word: leverage. If you look at Starbucks over the last five years, you'll notice the gross profit has jumped 56.1%, while at the same time selling, general, and administrative expenses, or overhead, have only gone by 34.5%. In other words sales are rising at a faster clip than expenses which means more of each sale is hitting the bottom line. As the company grows, the overhead doesn't need to keep up the same pace.
China has a growing middle class and is now Starbucks' second-largest market. Starbucks is literally creating a coffee culture there. Scott Maw, Starbucks' CFO, pointed out in a recent presentation that the growing middle class is adopting the company's coffee at an accelerated pace toward a daily routine. What do you know, the people of China are just as susceptible as the rest of us to pumping their veins full of caffeine via a tasty beverage!
Consider that there are 1.3 billion people in China; around half of them live in urban areas, while around 68% of urban households are middle class. Check my math, but that seems to be a potential market of 442 million people and growing every day in the urban cities alone.
Dare I say that the China market could one day be bigger than the United States? Why not, it's true of certain other quick-service chains such as KFC!
Crunching some numbers
Now assume the current 20,519 locations doubles. Starbucks is planning for 1,500 new locations this year alone. Half of that is slated for the China and Asia region. There seems to be no sign of the company slowing down its unit expansion any time soon. If China one day merely equals the United States market, that would be 14,000 potential locations for that one country alone compared to a current number of 1,100. Forty-one thousand grand-total locations seems far from impossible. Keep that 41,000 in mind.
In 2003 the average Starbucks did around $600,000 a year in business. Now that figure is 33% higher at around $800,000. Assume over the long haul of greater than 10 years (if need be) that the figure jumps 33% again, to roughly $1.07 million. Using the 57% gross profit margin of last year, Starbucks will yield $610,000 in gross profit per location on average.
Now take that $610,000 multiplied by 41,000 locations and get $25 billion. Assume last year's $5.68 billion in overheard rises again by the previous 10-year rate of 34.5%, and you get $7.64 billion.
The $25 billion in gross profit minus $7.64 billion in overhead is pre-tax income of $17.4 billion. Back out, say, 35% in income taxes, and get net income of around $11.3 billion. At a $100 billion market cap, that would be a P/E of less than 9.
Whoa, this may be bigger than we thought
Compare that to, say, McDonald's, which is arguably a company that has for the most part already saturated the market (there I go again.) It trades with a P/E of around 18, or double that of my Starbucks example. Based on the above assumptions, we could actually potentially see Starbucks at a $200 billion market cap based on the 18 P/E from McDonald's.
I know, it all sounds great on paper. But can Starbucks really grow earnings from $1.7 billion in the latest fiscal year to $11.3 billion, or even, say, half that ($5.65 billion) in order to justify a $100 billion market cap? It may sound crazy now, but I thought it sounded crazy too that Starbucks was "just getting started" in 2003 when it earned $268 million. Now those earnings are six times higher on four times higher sales. When it comes down to it, I wouldn't bet against Starbucks.