Financial Research Report

Financial Research Report

FIN 534 – Financial Management

Introduction

As a financial manager, one of the job qualifications is to research investments for clients, while ensuring that they align with the investment goals of the clients. Not only is it important to do thorough research in order to make the best recommendation possible for this encounter, but to ensure that everything is done to the utmost ability in order to drum up repeat business from the client. The current client is interested in various U.S. publicly traded company stocks that will provide investment growth long-term. The client already has a decent portfolio and is looking to expand it into various other industries, more specifically the retail industry. Quantitative and qualitative data will be evaluated in order to determine if the stock being considered will in fact align with the client’s goals. The stock that will be researched for potential investing is Starbucks Corporation (SBUX).

Company Information

Starbucks started as a roaster and retailer of whole bean and ground coffee, tea and spices back in 1971 out of a single storefront located in Pike Place Market in Seattle. A man named Howard Schultz took a trip to Italy in 1983 and came back with a vision to incorporate the Italian coffeehouse tradition to the United States. In 1987, Schultz, along with local investors, purchased Starbucks and did just that. Starbucks is a place that celebrates coffee and the rich tradition behind it, but its storefronts bring a feeling of connections. Their mission is: “To inspire and nurture the human spirit – one person, one cup and one neighborhood at a time” (Starbucks, 2018). Today, Starbucks is one of the leading coffee retailers in the world, using both technology and innovative ideas to not only stay relevant but continue to grow. Today, in addition to selling coffee Starbucks sells handcrafted beverages, merchandise, fresh food and consumer products (i.e. – k-cup pods and bottled beverages).

Rationale

As previously stated, the client is looking for an investment that will provide returns long-term and Starbucks is a company that will do just that. Some factors that led to the consideration of Starbucks are their financial success, company growth and innovations, and social and environmental commitments. Some data gathered relevant to financial success, focusing on the past year, revenue increased 10% from $22.4 billion to $24.7 billion. In addition to increased revenue, Starbucks was also able to return $8.9 billion to their shareholder through a combination of dividends and stock repurchases.

One company innovation was the release of Starbucks’ mobile order-and-pay feature on their store app. Due to this innovation, nearly 33% of all order were paid for by using the company’s app. To put this into perspective, Apple released Apple Pay a year before Starbucks released their order-and-pay feature, and yet “only 5.5% of iPhone users actually choose the option” (Eule, 2017). Starbucks has helped to change consumer payment behavior in a way that works to their advantage. As of August 2017, Starbucks owned and operated 26, 736 stores. By 2021, the number of stores is projected to be around 37,000, with approximately 5,000 opening in the China/Asia -Pacific region. In addition, the past six times that Starbucks has increased their dividends, it has been at 23% or greater, showing exceptional growth if they are able to offer their shareholders an increase in their dividend income.

Social and environmental commitments are the heart and soul behind Starbucks corporate culture – otherwise known as the ‘Starbucks Effect’. They have strived to deliver value to their shareholders by doing things a bit differently, by “focusing on [their] partners and customers, rather than just the bottom line” (Business Wire, 2006). One such example was when Starbucks sold Ethos Water. For every bottle of Ethos Water sold, $0.05 of the purchase went towards the goal of contributing $10 million between 2006 and 2010 to help various organizations alleviate the world water crisis.

Another example is by offering premium prices to coffee farmers who supply them with high quality coffee. By doing this, the farmers can make a profit and reinvest that profit back into their farms. There was one farmer who wrote to Starbucks after a hurricane hit his country, thanking them for their stance on sustainable agriculture, as it allowed his farm to remain relatively undamaged as a result. Starbucks also contributes to their local communities “through [investing in] local programming, in-kind donations, encouraging partner volunteerism, corporate cash contributions, and The Starbucks Foundation” (Business Wire, 2006).

Howard Schultz is quoted saying, “We live our mission statement and guiding principles through active involvement in our communities – whether it is a local neighborhood or a coffee growing country where we purchase coffee. Starbucks commitment to communities is more than just financial. We provide our expertise, volunteer time and product to help create lasting relationships” (Business Wire, 2006). While these factors and qualities are mainly internal and part of the corporate culture, they can help lead to positively trending intrinsic value. As a result, all these factors combined would make this stock a good investment for the client.

Suitability

The client is an individual whose focus is finding a company with long-term investment value, while also fitting into their social and environmental advocacies. In short, the client wants to find a company that provides long-term returns and aligns with their ethical, social, and environmental views.

Nine qualities that the global top ten companies have in common are high scores in: (1) innovativeness, (2) quality of management, (3) long-term investment value, (4) social responsibility, (5) people management, (6) quality of products and services, (7) financial soundness, (8) use of corporate assets, and (9) effectiveness in doing business globally (Brigham & Ehrhardt, p.3). These are important to mention as they are qualities that the client has looked at in the past when trying to determine whether to purchase a stock. Financial soundness and long-term investment value are extremely important to the client. If a company is not financially sound, purchasing a stock may equate to throwing good money after bad. Long-term investment values are important as the client is looking for a company, he can have stock in for the long haul. Corporate culture (social responsibility, people management, and quality of management) are also important since these can positively or negatively influence the profitability of the company. A company with a bad corporate culture can carry a bad reputation, which can lead to inversely effecting the company’s overall intrinsic value.

The client has a diverse portfolio since diversification can help to reduce risk exposure. “Almost half of the risk inherent in an average individual stock can be eliminated if the stock is held in a reasonably well-diversified portfolio, which is one containing 40 or more stocks in a number of different industries” (Brigham & Ehrhardt). Due to this belief, the client is trying to increase their diversification and grow their portfolio by obtaining stock in over 40 companies with a good variation in industries. The goal of the client is to decrease the weight of each of the stocks so the risk level for each one decreases, while still provided the client with market gains.

Financial Ratios

Current Ratio

The current ratio is a liquidity ratio which shows the relationship between a firm’s current assets and current liabilities. It is a measure which shows a firm’s ability to meet maturing debt obligations. Starbucks current ratio for the past three years (2015-2017) are as follows:

2017 2016 2015
5283.4/4220.7 =1.25 4760.5/4546.9 =1.05 4352.7/3653/5 =1.19

Shareholders typically look for stocks that have a relatively low current ratio. This is because high current ratios could mean that either the company has a lot of money that is tied up in nonproductive assets or there are large inventory holdings that might become obsolete before they can be sold. The current ratio for the industry average is 2.2. Because the current ration of Starbucks over the past three years is lower than the industry average, investing in the firm is a sound move.

Quick Ratio

The quick ratio is also a liquidity ratio, measuring the firm’s ability to pay off short-term obligations without relying on the sale of inventories. This ratio will help to determine how likely Starbucks is able to pay off any short-term debt they may have without having to liquidate their inventories in order to pay off their liabilities. During a bankruptcy, inventories are the assets where losses are most likely to occur. Starbucks quick ration for the past three years are:

2017 2016 2015
5283.4 – 1364.0/4220.7 = 0.93 4760.5 – 1378.5/4546.9 = 0.74 4352.7 – 1306.4/3653.5 = 0.83

The industry average is 2.0, indicating that compared to other firms within the same industry Starbucks would have to sell off some of their inventories in order to pay off their current liabilities. This is a cause of concern for shareholders as it indicates that Starbucks is not very liquid. The increase from 0.74 in 2016 to 0.93 in 2017 shows that Starbucks is becoming better at becoming more liquid.

Return on Equity

The purpose of shareholders investing in companies is to earn a return on the money they put in. The return on equity ratio helps tell shareholders how well they are doing with their investments. The return on equity ratio for Starbucks for the past three years are:

2017 2016 2015
391.4/5450.1 =7% 318.2/5884.0 = 5% 249.9/5818.0 = 4%

The return on equity industry average 3.8%. This indicates that Starbucks’ return on investment is on par with the industry. While the numbers may not appear very appealing, the steady increase in shareholders’ return from year-to-year is an indication that the firm is growing at a relatively steady pace. These numbers are preferable since firm’s with extremely high ROE is due to a small equity compared to net income, which is an indication of risk. Based on these numbers, Starbucks is a good firm to invest in.

Debt Ratio

The debt ratio shows how much of a firm’s assets are financed by debt; shows how much of the company is financed with debt as opposed to assets. This ratio serves as the extent of the leverage a company has. The debt ratios of Starbucks for the past three years are:

2017 2016 2015
3932.6/14365.6 = 27.3% 3202.2/14329.5 =22.3% 2347.5/12446.1 =18.9%

The industry averages a debt ratio of 40%. Due to the type of industry and the typical volatility within the industry, Starbucks’ debt ratio for the past three years shows that the firm can borrow money relatively easily compared to the industry overall. While 22% and 27% may seem high for some industries, based on the capital expenditures that go into running a Starbucks location, the debt ratios are decent.

Total Assets Turnover Ratio

The total assets turnover ratio is the measurement of the sales dollars that are generated for each dollar tied up in assets. It helps to shed light on how much business a firm generates in relation to total asset investments. It highlights how efficiently a firm can use its assets. The total assets turnover ratio for Starbucks in the last three years are:

2017 2016 2015
22386.8/14365.6 =1.6 21315.9/14329.5 =1.5 19162.7/12446.1 =1.5

The industry has an average total assets turnover ratio of 1.28. Because Starbucks’ numbers slightly beat out the industry average, it indicates that Starbucks generates slightly more business in relation to other businesses within their industry. Starbucks has discovered a way to use their assets in an efficient manner that results in more business, which results in greater sales, greater revenue, better intrinsic value, and greater returns for shareholders. Based on the five ratios discussed, while Starbucks shows the potential for improvement, their current numbers show that their current growth is relatively stable and is a good investment for shareholders looking for long-term returns.

Risk Level and Strategies

Based on the financial review, the level of diversifiable risk for investing in Starbucks is low to moderate. Regarding internal risk, the fact that Starbucks isn’t as liquid as other businesses within its industry is a slight cause of concern. Based on their financials and the quick ratio, if they have a worst-case scenario happens, they would have to sell their inventories in order to cover the cost of their current liabilities. While this factor might be a slight cause for concern, it is not a major one. As of the beginning of October in 2017, Starbucks had a negative beta of -0.21. This means that the firm’s stock will have a small risk on the client’s portfolio. Also due to the negative beta, if the market goes down then the investment would increase. Currently, Starbucks has a beta of 0.25 which indicates that there is less risk to the portfolio, but the potential gains are low. Due to the low risk on the client’s portfolio, a recommended strategy would be to ensure that the portfolio is diversified with stocks of both low and high risk. This would be an ideal strategy for any portfolio as it would not only diversify the risk but the gains and losses as well. Owning stock with high betas would be risky but would bring higher gains, while stocks with low betas are less risky with lower gains.

Recommendations

It was previously mentioned that there was diversifiable risk in relation to Starbucks stock, which is risk that is caused by random events that are unique to a firm. There are also market risks, which is risk that stems externally such as: war, inflation, recessions, and high interest rates. There are three market risks that should be considered when deciding whether to go ahead with investing in the firm. The first is competition within the industry, more specifically downscale competition. Dunkin Donuts and McDonalds have been working towards attracting more coffee customers to their locations (‘3 risks for Starbucks investors’). While Starbucks has strength on its side due to the lifestyle brand it has created for itself, it is not immune to declining economic conditions.

Another risk is the threat that online channels present to brick-and-mortar retailers. The fewer customers who are going out and about shopping, the fewer customers there are stopping by their local Starbucks. One way in which Starbucks has attempted to stymie the decline due to e-commerce is through their online app. International market changes could also adversely affect Starbucks’ stock. If the international markets become volatile, then that could spell disaster or slower growth than projected for Starbucks (‘3 risks for Starbucks investors’). While these external risks seem extreme, they are similar ones facing other companies, and there is nothing that can be done but to keep an eye out on any changes in the economy and taking necessary action should the need arise.

There was an article published in the University Wire that looked at Starbucks’ dividend potential. The article states that Starbucks’ earnings have risen in conjunction with its dividend increases. For the past six years, the gains in both earnings and dividends were almost identical. This means that Starbucks’ “dividend hikes are funded by growing profits and not by debt or cash on hand” (‘A close look at Starbucks’ dividend potential). This means that if shareholders see an increase in dividends, it most likely means that the earnings of the company have grown at a similar rate.

Starbucks has made strides to reinvigorate its business, and the results of those plans can be seen in the improvement from quarter three to quarter four of this year. According to the Motley Fool, the plans include “efforts to accelerate growth in the U.S. and China, expand the reach of the Starbucks brand, and focus on increasing shareholder returns by streamlining and simplifying operations” (Sparks, 2018). Starbucks hadn’t been doing too good for most of the year, yet during the fourth quarter, Starbucks saw significant growth. Same-store sales increased by 2% both in the United States and China, the earning per share increased to $3.24 showing a 65% increase, and net revenues rose by 10% (Kline, 2018).

Based on the quantitative and qualitative data that was gathered regarding Starbucks, this would be a good stock for the client to invest in. There are many factors and sources out there that see Starbucks as being a bad investment, but there are just as many that see Starbucks as a good investment and in fact encourage investors to buy in while the buying is good. A perfect example would be the most recent fiscal year, 2018. The company came upon hard times during the first three quarters which was reflected in the lowered stock prices. However, in the fourth quarter, they were able to turn things around and saw significant growth considering the type of year they had before. This comeback story from the third quarter to the fourth shows Starbucks’ resilience. The fact that they did something to turn their numbers around shows that Starbucks is a company that truly values its shareholders and will do what it can to ensure they are making a profit. While Starbucks may hit a few bumps in the road along the way, it is highly recommended that this is a good stock to invest in.

Ultimately, the decision of whether to invest comes down to the client. They can decide to take the considerations to heart, or to completely ignore them and go a different route. All that can be done is to weigh the pros and cons, while providing as much information as possible to see if investing in this stock will truly be the best course of action for the client.

References

3 risks for starbucks investors. (2017, Jan 31). University Wire Retrieved from

https://search.proquest.com/docview/1863082599?accountid=30530.

A close look at starbucks’ dividend potential. (2016, Aug 28). University Wire Retrieved from

https://search.proquest.com/docview/1814516727?accountid=30530.

Brigham & Ehrhardt. (2017). Financial Management: Theory and Practice (15th ed). Boston,

MA: Cengage Learning.

Eule, A. (2017). THE FUTURE OF COFFEE (AND RETAIL). Barron’s, 97(34), 17-19.

Retrieved from https://search.proquest.com/docview/1930858432?accountid=30530.

Investopedia. (2018). Debt Ratio. Retrieved from

https://www.investopedia.com/terms/d/debtratio.asp.

Investopedia. (2018). Return on Equity (ROE). Retrieved from

https://www.investopedia.com/terms/r/returnonequity.asp.

Kline, D. (2018). Why Starbucks Is Up 19% in 2018. Retrieved from

https://www.fool.com/investing/2018/11/13/why-starbucks-is-down-16-in-2018.aspx.

Sparks, D. (2018). Starbucks Management Talks Customer Service, Digital Marketing, and

More. Retrieved from https://www.fool.com/investing/2018/11/17/starbucks-management-talks-customer-service-digita.aspx.

Starbucks annual meeting of shareholders starts over a cup of coffee; company’s impact now

extends well beyond stores’ four walls. (2006, Feb 08). Business Wire Retrieved from https://search.proquest.com/docview/445284187?accountid=30530.

Starbucks. (2018). Starbucks Company Profile. Retrieved from

https://www.starbucks.com/about-us/company-information/starbucks-company-profile.

Starbucks. (2016). Starbucks Fiscal 2015 Annual Report. Retrieved from

https://s22.q4cdn.com/869488222/files/doc_financials/annual/2015/Starbucks-Fiscal-2015-Form-10-K.pdf.

Starbucks. (2017). Starbucks Fiscal 2016 Annual Report. Retrieved from

https://s22.q4cdn.com/869488222/files/doc_financials/annual/2016/FY16-Annual-Report-on-Form-10-K.pdf.

Starbucks. (2018). Starbucks Fiscal 2017 Annual Report. Retrieved from

https://s22.q4cdn.com/869488222/files/doc_financials/annual/2017/01/FY17-Starbucks-Form-10-K.pdf.

Yahoo Finance. (2018). Starbucks Corporation (SBUX). Retrieved from

https://finance.yahoo.com/quote/SBUX?p=SBUX.