Starbucks: Perk Up Your Portfolio

03/17/2014 8:00 am EST

Focus: STOCKS

This featured recommendation—a leading player among coffee chains—has a great business model that is executed flawlessly; indeed, it is one of our favorite companies in the world, says Briton Ryle in The Wealth Advisory.

Starbucks (SBUX) has 20,184 locations in 60 countries. Starbucks buys more than half a billion pounds of “green” (unroasted) beans from more than 300,000 growers a year. That’s about 3% of the world’s supply.

Starbucks reported $0.71 per share for Q4 earnings versus expectations of $0.69. Revenues came in at $4.2 billion. Net income for 2013 hit $530.7 million, up from $432.4 million in 2012.

In fiscal 2013, Starbucks repurchased approximately 10.8 million shares of its common stock for roughly $588.1 million.

Add in dividend payments totaling $628.9 million, and this means Starbucks returned over $1.2 billion to its shareholders in 2013. Starbucks’ payout ratio is below 50% of earnings, so there is room for growth.

One of the keys to Starbucks' success is its gift cards. In Q4 (which is Starbucks fiscal first quarter), its customers added $1.4 billion to gift cards. For fiscal 2013 (which ended September 29), people loaded $3.7 billion onto Starbucks cards, up 27.5% from a year earlier.

At this rate, card loads will easily eclipse $4 billion in fiscal 2014. That’s roughly equivalent to one quarter’s worth of revenue. Starbucks can’t recognize gift card cash as revenue until it is actually spent at a store. But it can invest it.

Starbucks money managers buy high-grade corporate bonds, Treasury notes, and certificates of deposit that mature in three to 12 months. In the past four quarters, Starbucks has made $146 million on interest alone, or 8% of total profit.

Bloomberg reports that Starbucks generates more free cash relative to its debt than any US restaurant chain. What’s more, of the 11 consumer-discretionary companies in the S&P 500 (SPX) with market values bigger than $50 billion, Starbucks has the least debt.

Starbucks expects to grow earnings 13% in 2014. If we simply add that to the current valuation, we can get a price target of $84.50. Starbucks will likely beat that 13% growth rate (it grew net profits 22% last year).

We added Starbucks to The Wealth Advisory portfolio in October 2012 at $45.59. We have maintained a “hold” rating on the stock for months. It’s time to get Starbucks back in the “buy” column.

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