Undervalued Dividend Growth Stock of the Week: Starbucks (SBUX)

Value for money.

It doesn’t matter what I’m buying or doing.

I’m always looking for the best value for money.

Paying more than one should for anything in life is a bad idea.

Conversely, getting a great deal, especially on high-quality merchandise, can have a tremendous long-term impact on your wealth.

This is a concept I’ve stayed true to as I’ve gone about managing my finances and investing my capital.

And it must have worked out pretty well – I retired in my early 30s.

I share the details of how I accomplished that feat in my Early Retirement Blueprint.

Suffice it to say, a big part of my success has been getting the best value for money on the best long-term investments.

Regarding that latter point, my mind always goes to high-quality dividend growth stocks.

These are stocks that represent equity in world-class enterprises paying reliable, rising dividends.

They’re some of the best stocks in the world.

That’s because they’re slices of ownership in some of the best businesses in the world.

You can find hundreds of these stocks over at the Dividend Champions, Contenders, and Challengers list.

I’ve invested solely in these stocks over the years.

And I built the FIRE Fund in the process.

Jason Fieber's Dividend Growth PortfolioThat’s my real-money dividend growth stock portfolio, which produces enough five-figure passive dividend income for me to live off of.

But even high-quality dividend growth stocks can perform poorly, particularly over the short term, if one isn’t mindful about value for money.

This comes down to a stock’s valuation.

While price is what you pay, it’s value that you get.

An undervalued dividend growth stock should provide a higher yield, greater long-term total return potential, and reduced risk. 

This is relative to what the same stock might otherwise provide if it were fairly valued or overvalued.

Price and yield are inversely correlated. All else equal, a lower price will result in a higher yield.

That higher yield correlates to greater long-term total return potential.

This is because total return is simply the total income earned from an investment – capital gain plus investment income – over a period of time.

Prospective investment income is boosted by the higher yield.

But capital gain is also given a possible boost via the “upside” between a lower price paid and higher estimated intrinsic value.

And that’s on top of whatever capital gain would ordinarily come about as a quality company naturally becomes worth more over time.

These dynamics should reduce risk.

Undervaluation introduces a margin of safety.

This is a “buffer” that protects the investor against unforeseen issues that could detrimentally lessen a company’s fair value.

It’s protection against the possible downside.

Getting the best value for money on the best investments almost guarantees you incredible success, wealth, and passive income over the long run.

Of course, getting the best value for money requires an investor to have a pretty good idea of what a stock is worth.

Fear not.

Fellow contributor Dave Van Knapp put together Lesson 11: Valuation in order to help investors estimate intrinsic value for themselves.

Part of an overarching series of “lessons” on dividend growth investing, it provides a valuation template that any investor can easily understand and use.

With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…

Starbucks Corporation (SBUX)

Starbucks Corporation (SBUX) is the world’s leading retailer of high-quality, specialty coffee products. These products are sold in 34,000 stores across 80 different markets, in addition to multi-channel retail.

Founded in 1971, Starbucks is now a $114 billion (by market cap) global coffee shop juggernaut that employs nearly 400,000 people.

Company-owned stores accounted for approximately 84% of FY 2021 revenue, while licensed stores accounted for approximately 10% of FY 2021 revenue. Other sales made up the remainder.

The company splits its revenue across two primary geographical segments: North America, 70% of FY 2021 revenue; and International, 24%. Channel Development (retail CPG), as well as Corporate and Other accounted for the remainder of revenue.

The U.S. is by far the company’s largest single market, comprising 45% of the global store count. China is their most important international market, comprising 16% of the company’s total global store count.

Whereas a lot of companies try to offer either a great product or a great experience, Starbucks does both.

They offer high-grade coffee-based products that customers thoroughly enjoy.

And they offer a unique “home-away-from-home” experience to customers who want to sit in their lounges while they enjoy said coffee-based products.

As someone who personally creates content while at a coffee shop almost every day, I can attest to the appeal and value of this product-experience combination.

This is a recipe for success that Starbucks has used to become a $100+ billion company.

And even inflation is unlikely to bring them down.

Starbucks lays claim to one of the biggest and best brands on the planet, which gives them a rare degree of pricing power.

They have millions of loyal customers who repeatedly buy their products every day. This positions them really well in a new paradigm where inflation is suddenly a concern once again.

But wait, there’s more.

Starbucks was already a world-class enterprise heading into the pandemic, with its leading market share built on global acclaim and recognition.

However, it could end up even more dominant after the pandemic subsides, as a lot of independent coffee shops lacked the financial wherewithal to stay open throughout the crisis.

This puts the company in a highly favorable spot, which should allow them to continue growing their revenue, profit, and dividend at a high rate for years to come.

Dividend Growth, Growth Rate, Payout Ratio and Yield

The company has increased its dividend for 12 consecutive years.

And I think that’s just the start for them.

Their 10-year dividend growth rate is really strong, at 20.7%.

That double-digit dividend growth is paired with a starting yield of 2.0%.

This yield easily beats the market.

It’s also 30 basis points higher than its own five-year average.

With a moderate payout ratio of 52.8%, there’s still plenty of room for Starbucks to continue aggressively growing the dividend – especially with the business growing at a healthy rate.

I see these dividend metrics as very appealing.

Revenue and Earnings Growth

As appealing as these dividend metrics might be, though, they’re largely looking at the past.

However, investors risk today’s capital for tomorrow’s rewards.

Thus, I’ll now build out a forward-looking growth trajectory for the business, which will later aid in the valuation process.

I’ll first show you what the company has done over the last decade in terms of its top-line and bottom-line growth.

And then I’ll reveal a near-term professional prognostication for profit growth.

Comparing the proven past with a future forecast in this way should give us a reasonable picture of the company’s growth profile as we go forward.

Starbucks has increased its revenue from $13.3 billion in FY 2012 to $29.1 billion in FY 2021.

That’s a compound annual growth rate of 9.1%.

I usually look for mid-single-digit top-line growth from a fairly mature business like this.

Starbucks blew away my expectations here.

Meanwhile, earnings per share moved from $0.90 to $3.54 over this 10-year period, which is a CAGR of 16.4%.

Again, very impressive.

A combination of margin expansion and share buybacks helped to drive the excess bottom-line growth.

Buybacks reduced the outstanding share count by 23% over the last decade.

Looking forward, CFRA believes that Starbucks will compound its EPS at an annual rate of 12% over the next three years.

While this wouldn’t quite reach the lofty heights of what the company produced over the last decade, 12% EPS growth would still be a fantastic growth rate for a large, established company like this.

I think it’s important to note that Starbucks has two huge growth drivers working for them simultaneously.

First, the company continues to open new stores. Starbucks plans to open a total of 2,000 net new stores in 2022, and they opened 484 net new stores in Q1 FY 2022.

Second, their existing stores are sporting fantastic comps. In its Q1 FY 2022 print, Starbucks reported comparable store sales up 13% globally. It’s hard to overstate just how incredible that is.

I see CFRA’s near-term EPS growth forecast as prudent, if conservative. For perspective, the company’s Q1 print, which was released only days ago, showed 30% YOY EPS growth.

If we take this 12% EPS growth rate as our baseline, that sets up Starbucks to deliver similar, or better, growth in the dividend

And that’s a compelling setup when you’re also locking in a 2% yield.

Financial Position

Moving over to the balance sheet, Starbucks has a very good financial position.

Negative shareholders’ equity clouds the picture, but $13.6 billion in long-term debt on a $114 billion market cap is relatively negligible.

The interest coverage ratio is over 12, which further shows that Starbucks has no issues with servicing its debt.

Profitability is robust.

Over the last five years, the firm has averaged annual net margin of 12.3%. ROE is N/A because of negative equity.

Starbucks is a world-class organization that is positioned to benefit from future spending on both products and experiences.

And the company does benefit from durable competitive advantages, including brand value, pricing power, economies of scale, a global distribution network, and a competent omnichannel strategy.

Of course, there are risks to consider.

Regulation, litigation, and competition are omnipresent risks in every industry.

While I view regulation and litigation as somewhat limited relative to many other industries, the QSR space is extremely competitive.

Input costs are volatile and rising, especially in terms of labor.

Being a global company, they’re exposed to macroeconomic issues and broad economic slowdowns. The pandemic is a perfect example of this.

Perhaps the biggest risk to long-term returns is the law of large numbers. Their massive size, huge store count, and market saturation could end up limiting growth vectors at some point.

Even with these risks out in the open, I still feel that Starbucks can make for an excellent long-term investment.

That’s especially true with the stock down 23% from its 52-week high and looking attractively valued after that drop…

Stock Price Valuation

The stock is trading hands for a P/E ratio of 26.3.

That’s way off of the stock’s own five-year average P/E ratio of 48.1.

Now, the company’s reported GAAP EPS can be lumpy, clouding this comparison.

However, there’s also a big disconnect in cash flow, which is a more accurate comparison.

The P/CF ratio of 19.2 is significantly lower than its own five-year average of 27.6.

And the yield, as noted earlier, is higher than its own recent historical average.

So the stock looks cheap when looking at basic valuation metrics. But how cheap might it be? What would a rational estimate of intrinsic value look like?

I valued shares using a dividend discount model analysis.

I factored in a 10% discount rate and a long-term dividend growth rate of 8%.

This dividend growth rate is at the top end of the range I use.

But I think Starbucks is the kind of business that deserves it.

This 8% mark is lower than the company’s demonstrated long-term EPS growth and dividend growth.

It’s also lower than the company’s near-term EPS growth expectation.

With the payout ratio being moderate, I see no reason why Starbucks can’t increase the dividend at a high-single-digit rate for many years to come.

The DDM analysis gives me a fair value of $105.84.

The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.

The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.

It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.

I find it to be a fairly accurate way to value dividend growth stocks.

I don’t think my valuation was aggressive at all, yet the stock still looks undervalued.

But we’ll now compare that valuation with where two professional stock analysis firms have come out at.

This adds balance, depth, and perspective to our conclusion.

Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.

1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.

Morningstar rates SBUX as a 3-star stock, with a fair value estimate of $109.00.

CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.

They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.

CFRA rates SBUX as a 3-star “HOLD”, with a 12-month target price of $115.00.

I came out low this time around. Averaging the three numbers out gives us a final valuation of $109.95, which would indicate the stock is possibly 13% undervalued.

Bottom line: Starbucks Corporation (SBUX) is a high-quality company with global brand recognition, providing both in-demand products and in-demand experiences. With a market-beating yield, double-digit dividend growth, a moderate payout ratio, more than 10 consecutive years of dividend increases, and the potential that shares are 13% undervalued, long-term dividend growth investors would be wise to consider buying this stock after its big drop.

— Jason Fieber

P.S. If you’d like access to my entire six-figure dividend growth stock portfolio, as well as stock trades I make with my own money, I’ve made all of that available exclusively through Patreon.

Note from DTA: How safe is SBUX’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 67. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, SBUX’s dividend appears Safe with an unlikely risk of being cut. Learn more about Dividend Safety Scores here.

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Source: DividendsAndIncome.com