"Starbucks News Watch"

Starbucks Brews Up Successful Formula for Growth

Dec 18, 2005 (Chicago Tribune - Knight Ridder/Tribune Business News via COMTEX)

Coffee traditionalists may flinch at Starbucks Corp.'s winter offering, the Chai Eggnog Latte. But they're still flocking to buy their cups of Joe:

The seemingly ubiquitous coffee shop continues to awe competitors and detractors alike. In November, Starbucks' same-store sales rose 7 percent, roaring past industry forecasts and helping to sustain a recent surge in its stock price. As one of the country's great growth-stock stories, Starbucks continues to generate earnings above the market average, an extraordinary streak that has taken place every quarter since the company went public in 1992, said Ashley Reed Woodruff, restaurant analyst at Bear Stearns. Looking at Starbucks' fiscal 2006, which began Oct. 3, Wall Street analysts expect the company's earnings to grow 20 percent to 24 percent, and revenue to rise roughly 20 percent, to about $7.6 billion, according to Thomson Financial. Growth is something Starbucks knows, and knows well. Like any aggressive retailer, the Seattle-based chain continues to add products, such as breakfast, Baby Boomer CDs and seasonal favorites like a gingerbread latte. After the stock nearly tripled from the end of 2002 through 2004, Starbucks shares traded downward through much of this year as inflated growth expectations were not met. But this fall, as Starbucks defied the presumption that higher gasoline prices would cut into pricey coffee purchases, the stock rebounded. Starbucks shares are up 27 percent since the end of August. But the stock isn't cheap. Based on forward 12-month earnings, Starbucks' price-to-earnings multiple is around 40, well above the market's average of 15.5. Because Starbucks has historically traded at a 120 percent premium to the market, its current valuation is a bit pricey for Jim Margard, chief investment officer at Rainier Investment Management. Though Margard, whose firm manages $7.7 billion, owns a small amount of Starbucks in his aggressive growth fund, he hasn't included the stock in his much larger Rainier Core Equity Fund.

"We'relooking for growth at a reasonable price, and right now, though they're doing extremely well executing their business plan, we struggle with paying that premium," he said. Then again, the company's profit is growing at a clip well above the market's long-term earnings-per-share rate of 7 percent to 9 percent, said Woodruff. And that's the main reason she encourages investors to buy the stock. "The debate on Starbucks is always, do they deserve that historical multiple around 40? And we think it does," she said. "The P/E is high, but they're growing at 20 to 25 percent. If the multiple stays the same, and we think it will, you should see shares also rise 20 to 25 percent." Woodruff said stock-pickers should expect to pay extra for consistency. Rather than growing in sharp bursts and then falling backward, Starbucks has maintained same-store sales growth in the 7 percent to 9 percent range for years, she said. By all estimates, Starbucks remains an extraordinary growth company, buyer of 2.2 percent of the world's coffee. Locally owned coffeehouses be warned: Over its next fiscal year, Starbucks plans to open 1,300 new U.S. locations--stores, kiosks and licensed venues such as those in airports and hotels--and another 500 internationally. David Klaskin, manager of the Pioneer Oak Ridge Large Cap Growth Fund, agrees Starbucks is first rate. But he, too, isn't so sure its shares are a good buy. To compare Starbucks with other stocks, Klaskin uses the so-called PEG valuation. To calculate it, take a company's 12-month forward-price-to-earnings multiple and divide that by its annual earnings growth rate. The lower the figure, the more affordable the shares. Currently, the market's average is 1.5. Using a 20 percent to 21 percent annual growth rate, Klaskin calculates Starbucks' PEG multiple at 2.2. "That's not a great risk-reward," he said, adding that world coffee prices could rise and same-store sales growth could slow. Klaskin, though, isn't against buying stock in high-growth companies; rather, he's looking for companies with earnings that warrant what is a comparatively expensive share price. A favorite is Google Inc. Even with a forward P/E of 48 to 50, Klaskin said he's enamored with the company's consensus five-year growth rate of 33 percent. "The rationale is, I don't mind paying a 50 P/E if a company's earnings are above 30 percent," Klaskin said. "For Google, there's a lot of risk, but I think the reward is still great."

By Leon Lazaroff