What Is the Intrinsic Value of SBUX Stock?
From February 2019 to June 2020, I was a barista at Starbucks (ultimately getting phased out because of the Coronavirus). I ended up being there not quite long enough to benefit from stock options that partners (Starbucks workers) can receive. Nevertheless, I remain subscribed to r/starbucks and have made several visits to my old store. I keep in touch with my manager, who become a good friend of mine. I therefore still have a residual, personal interest in the company.
Recently I started studying the principles of investing, namely, a school known as value investing, which is associated with the likes of Warren Buffett and his teacher, Benjamin Graham. Where other investors see their work as investing “in the market,” value investors ignore the market and look at simply buying a company at a good price.
For example, if a single share of Company X is likely to give you $100 in earnings, is currently priced at $10, has low debt, and has competent management, a value investor would tell you to buy it immediately. The market clearly doesn’t know how to price it. Similarly, if the market price shoots to $200 the next week, but none of the fundamentals changed, the value investor would tell you to sell and invest your profit in another cheap company you had lined up. After all, it’s only worth $100 in earnings, not $200. If it doesn’t shoot up, then you hold it until does (perhaps forever) and patiently reap your delicious earnings in the meantime.
While I don’t have any shares of Starbucks (SBUX on stock exchanges), I recognize that many of my former partners do. The veteran staff may have quite a few at this point. Thus, this post may prove a friendly guide to my former co-workers, while also giving me to a chance to practice analysis and improve my technique. Let’s dig into it.
SBUX has a lot of the opening signs of being a safe investment. It’s a big company, with a recognizable name. It’s on the S&P 500, currently priced at $103 per share, so there is confidence. It’s been rattled by the pandemic but not toppled. This is because the power of the SBUX brand comes from the intense loyalty of its customers.
When the pandemic started, I was given disaster pay and took no shifts for about two months. I was entitled one free drink and food order per day, along with the other partners. As many will remember, the only stores in operation during the initial lockdown were the drive-thru stores, since those were the ones that could meet the parameters of social distancing. I was sure to take advantage of the perks whenever I could, and the irrational lines at those stores stood out like a sore thumb. At a time when people were afraid to go outside and catch the disease, people were still coming out strong for their lattes.
Stores have since reopened and are under mostly normal operations. Many of the regular customers at my old store have returned and are there everyday again. (Fun fact, some of them will still approach me and try to have lunch/dinner with me on the spot, if that tells you how much they love the brand.) This is a solid test of customer loyalty, and it’s not the only one. My store in particular had been destroyed in a flood by Hurricane Florence in 2018. I was hired as part of the crew that reopened it the following April, about nine months later and after a much longer period of closure. The regulars who had been there before still returned and became regulars again. Many of them stated how eagerly they had been waiting for the return of our store for that entire period.
SBUX took some hits, to be sure. This summer, it had to close 400 stores that couldn’t weather the lockdown, and it only opened 300 new locations (down from its initial plan of 600). Another 100 shutdown followed afterward. Still, over 30,000 remain in operation worldwide. SBUX is also not just a café. It sells its own coffee products in several grocery stores as well, and it has always done this.
Beyond that, though, SBUX had a lot of the tools to deal with a setback like the current recession. The fact that there were drive-thru stores at all is a testament to this. While traditionally treated as the “third place,” SBUX has nevertheless been evolving its company to get the customers in and out as quickly as possible, not so much to hang around anymore. Their app, which allows the most frequent customers to have a portable balance and earn rewards redeemable at any location, has also minimized the need for interactions at the cash register (and also ensures Starbucks is paid upfront). The ability to place mobile orders, so that people can grab their drink and go, only adds to this. This was true even before the pandemic.
By including new practices such as curbside pickups and allying with Uber Eats, SBUX managed to adjust its business model rather successfully, especially when compared with other companies in the food industry. While this may have been an expensive shift upfront, we have reason to think that these changes will provide long-term value for the company. After all, the pandemic has shown how much of our economy could be run either remotely or through automation. Necessity pushed us there faster than if we had simply realized it ourselves, but businesses like SBUX may find that they are more competitive in the Twenty-First Century for these changes. They may find a lack of necessity to revert to the old ways.
The relationship between SBUX and its partners is mixed. The previous section may indicate why. While having origins in the Pacific Northwest (a friendlier region to workers than most of America), many older members of the company feel like the corporate mega-giant no longer takes the wishes, input, and needs of the partners as seriously as in the past. Wages are low (currently around $10 per hour). Tips are included on top of that, and partners get free drinks and free food every day. Perhaps the value could be considered $12 per hour, if we are optimistic. Many will still find overtime opportunities (or even a full 40 hours) scarce. It’s certainly better than delivering pizzas (I’ve also done that), but many partners do not feel adequately compensated, particularly given the health risks at the moment.
Incentives are not aligned with productivity. Corporate wants speed increased, errors reduced, extra flavors/toppings sold, and customer rapport established. No partner who excels at these shall receive a bonus for it. Many of them are there to tolerate their shift, run down the clock, and go home with a drink in hand. Consequently, turnover is high, and this creates grief for the partners who remain on staff because they have to put out the fires of newbies’ mistakes: incorrectly entered orders, ignorance of drink formulae, getting lost in the back-stock, and many other things.
While this probably means SBUX has a lot of unnecessary costs for right now, it also makes sense, given the direction the company wants to go. The “hand-crafted beverage” is a romantic concept, but realistically SBUX is looking at a future where the barista is replaced by a machine, and one day we may even see drones hovering around with orders to people’s homes or office. The third place won’t be at the store but in our memories. SBUX is not interested in developing the careers of its staff anymore or the personal touch. It has been in a gradual shift over the years toward gaining value from its non-human capital. While this is bad for anyone who works there, to the value investor, this means that payroll costs will likely become a smaller part of the company’s overall costs, while still selling its goods at a massive scale.
The real issue comes to the management. SBUX’s rise from 80s to 2010 was impressive. The previous decade has seen a lot of tooth-and-nail efforts by Starbucks to increase sales. The company was sustaining its expansion with debt, and any value investor will tell you that growth with debt is not really growth at all.
SBUX’s equity (assets minus liabilities) is a negative now, as is the case for many businesses. This, however, was the state of the company before the pandemic hit, so that means if you are going to own SBUX, it’s going to have to be at a really good price, and you have to trust that negative equity is only a brief inconvenience. While Starbucks probably will not go out of business, as an investor, you’re looking for strong returns, and neither Schultz nor Johnson have given investors a company that’s likely to do that at a good price.
Now we need to see what a good price to buy Starbucks is. To reiterate, it currently trades at $103 per share. Is that a bargain?
A very straightforward way to evaluate a stock is to look at the book value (equity of the company per share) and then add its projected earnings. This is a bit tough to do because the equity is currently negative. When it was last positive in 2018, the book value would have only been $0.89 per share. Assuming the book value doesn’t drop anymore and a consistent dividend of $1.26 per year, a ten-year investment makes SBUX worth about $12 per share. A value investor would try to buy at $5 or $6 per share. Considering everything I just said, though, even $12 is generous.
Remember the scenario I mentioned about selling when your stock is overpriced? Well, in my opinion, SBUX is grotesquely overpriced at $103, and partners who have held shares will probably be better off selling them and putting that profit into better buys, even taking into account capital gains.
By comparison, Warren Buffett bought Coca-Cola at just over $2 per share in 1989. It’s now worth $55 per share and pays $1.60 in dividends per year. That was a bargain. And the thing is: Coca-Cola and Starbucks are both great brands, but whether they are great investments depends on the price. Buffett got to buy Coca-Cola low. You get to sell Starbucks high. Either of these is a win.
Before the company is worth buying, the market needs to catch up with reality. Most of this growth in share price has been in the last two years, which is also when this debt started to become monstrous, so that should tell you something.
Anyway, thanks for spending your time reading my two cents. Best of luck to my fellow partners as the pandemic continues!