I'm sure there are better investing one-liners than, "Invest in what you know," but it's still near the top of the list. If you're a walking, breathing adult, you probably know about Starbucks (NASDAQ:SBUX).
Investing in Starbucks probably also seems like a good idea. The company's stock has risen 250% in the last five years, beating out the rest of the market by 175 percentage points.
Does that mean the stock is overcooked? Is it all downhill from here? Potential Starbucks investors have a lot of questions, so here are a lot of answers.
Free cash flow at Starbucks
Let's talk about raw numbers to get things started. When looking at any business, the one thing we ultimately want to know is, "Did you make money?" We often start up at the top and work our way down to discover that the $17 trillion in sales somehow ended up squandered along the way, and the company is only recording $2 million in earnings. To cut to the chase, let's look at free cash flow.
Free cash flow is the actual cash that a company generates. If we look at Starbucks, for instance, we can see that, during the first nine months of its fiscal year, it actually lost $133 million in cash just running itself. That seems odd, though, because in the year before, it generated $2 billion in cash through its continuing operations.
The trick is that, in 2014, the company finished a long running bit of legal trouble with Kraft -- and Kraft won. That resulted in a $2.8 billion fine for Starbucks, which came out of its bottom line. Because that's not a recurring issue, we can add that back in to determine what Starbucks would have made, if 2014 was a normal year.
Through its ongoing operations, Starbucks would have made $2.6 billion. We then subtract out the cash that the company spent on property and equipment, as that's cash that the company would presumably continue to spend to keep itself growing at its current rate. During the first nine months of fiscal 2014, the business invested $811 million in property and equipment, giving us $1.8 billion in free cash flow. That's cash that Starbucks can use to reinvest, buyback shares, payout as a dividend, or even pay off a legal settlement.
Sales and growth
Looking beyond Starbucks' cash flow, let's talk about growth. During the first nine months of this fiscal year, Starbucks has grown same-store sales by 6%. That means that the company is attracting more customers to its locations, and it's selling them more things. That's a recipe for strong fundamental growth, and one that Starbucks has been perfecting for years.
Now that coffee is locked in, Starbucks is setting its sights on other growth opportunities. Food and tea offer the biggest chance at new success, and the company is working on each one. For food, Starbucks is expanding its baked goods and prepared foods offerings. That's to help it focus on bringing in more customers during the evenings and afternoons.
Tea is Starbucks' other focus, with its Teavana acquisition and expansion. The company believes that it can "reinvent the way the world enjoys tea, just as Starbucks did, decades ago, for coffee." That means building the Teavana brand, expanding its physical presence, and getting more visibility in Starbucks' locations for the tea brand.
Concerns about the future
The growth that Starbucks is pushing for in food and tea isn't without expense. Starbucks puts a lot of work into the products and lines it promotes, and those have taken a toll on short-term earnings. The company's catch-all "other segments" business reported a $19 million operating loss due to investments in its emerging businesses.
If those investments don't turn into revenue, Starbucks is left holding the bill. For a company that is constantly developing new items and trying to squeeze more out of each location, that can quickly add up.
Tied to the investment cost concern is the cost of commodities. Coffee and milk are the backbone of Starbucks' business model, and rising rates of leaf rust along with climate change concerns mean that coffee's future price is still unclear. Starbucks has been able to pass on some price increases in the past year, but consumers have a limit. If Starbucks just has to keep prices down to keep customers, its margins could be in serious jeopardy.
On top of cost issues are management concerns. Starbucks has always been the byproduct of CEO Howard Schultz's coffee-focused mind. At some point, Schultz is going to step down, and Starbucks could be left in the lurch. While leaders aren't synonymous with their businesses, Schultz is the force behind much of the business, and it seems unlikely that there's another Schultz waiting in the wings.
Finally, Starbucks isn't cheap. The company trades at 3.4 times its total sales, which is higher than many established brands, and more in line with growth businesses in the industry. With many concerns about future costs and growth, Starbucks is far from a sure bet.
Investors looking for a strong brand and the potential for greatness could certainly find success with Starbucks. If you're in the market for a value proposition, however, Starbucks is the wrong place to look. This is a company priced for bigger things. If they fail to materialize, Starbucks shareholders will have a long way to fall.