Starbucks Coffee Overvalued Stock Despite Strong Growth Pros

							Starbucks Coffee Overvalued Stock Despite Strong Growth Prospects Business Analysis and Security Val uation Prepared by Erik Eselius, Jon D. Taylor, Olivier te Boekhorst, and Peter Winters For Professo r Charles Lee Johnson Graduate School of Management, Cornell University April 29, 1997 TABLE OF CONT ENTS TABLE OF C 2 EXECUTIVE SUMMARY................................................................. ....................................................... 3 OVERVIEW OF STARBUCKS..................... .......................................................................................... 4 Busines s Ove 4 Recent Stock Performance.................................................................... .......................................... 4 COMPETITIVE ANALYSIS .................................. .................................................................................. 5 Rivalry Among E xisting Firms....................................................................................... ................... 5 Threat of New Entrants ....................................................... ............................................................. 6 Threat of Substitute Products....... .................................................................................................... 6 Bargaining Power of Buyers....................................................................... ...................................... 7 Bargaining Power of Suppliers.............................. ........................................................................... 7 STARBUCKS STRATEGY.... .................................................................................................... ............. 8 Channels .......... 8 Product Diversification ...................................... ............................................................................... 9 Human Res 10 Retai l Outlets.. 10 ACCOUNTING ANALYSIS.................................................................. ................................................. 12 Discussion of Key Items in Financial Statements .......................................................................... 12 Ratio Analysis: Profi tability and Productivity........................................................................... ....... 13 Earnings 15 Bankruptcy Prediction ...................................................... .............................................................. 17 EBO VALUATION. 18 EPS Forecasts .. .................................................................................................... ......................... 18 Long-term Growth Rate.................................................. ................................................................ 18 Cost of Equity. 18 Dividends ... .... 18 Target ROE.... 18 Stock Value .... 19 DISCOUNTED CASH FLOW ANALYSIS......................... ................................................................... 20 Cost of Capital 20 Sales Driv ers.. 21 Capital Expenditures ...................................................................... ................................................ 21 Terminal Valu 22 COMPARABLES ANALYSIS .......... .................................................................................................... . 23 Cross Sectional Du Pont Analysis............................................................... ................................... 23 Market Multiples ............................................ ................................................................................. 24 RECOMMENDATION .................................................................................................... ...................... 25 EXECUTIVE SUMMARY According to a popular Turkish proverb, "Coffee should b e black as Hell, strong as death and sweet as love". At Starbucks Coffee Company in Seattle, Washing ton, it's also as rich as gold. Starbucks is a well-managed, aggressive company that has achieved he ady growth since its inception. The company has earned its place in business history as an innovativ e firstmover and its brand is synonymous with quality. Nevertheless, after conducting a wide range o f qualitative and quantitative analyses, we see the market's enthusiasm for Starbucks as a cup that runneth over. On April 25th, Starbucks stock closed at $27-1/2. Our discounted cash flow model--usin g baseline assumptions for cost of capital, growth, and sales mix--generated a stock price of $8.52. Our most aggressive scenario produced a stock price of $23.09; the most conservative case produced $6.40. Starbucks is an impressive company with first-rate products and services, but it is, in our m inds, overvalued. Recommendation: Long the coffee and short the stock. In arriving at our recommenda tion, we used several analyses and techniques. After a company overview, we began with a competitive analysis that uses a five-force framework to discuss the specialty coffee industry. We then analyze d the company strategy, and followed that discussion with accounting analysis and stock valuation. O ur accounting analysis includes the Beneisch Model, a Z score, a discussion of key items in the fina ncial statement, and a competitive Du Pont ratio analysis. The stock valuation section comprises an EBO, a DCF, and market multiples. OVERVIEW OF STARBUCKS Business Overview Starbucks sells premium co ffee beverages and beans through company-owned and licensed retail outlets. The company's stated obj ective is "to establish Starbucks as the most recognized and respected brand of coffee in the world. " Through its retail outlets, the Seattle based company also sells bakery goods, confections, and co ffee equipment and merchandise. The company has expanded both its product line and its marketing cha nnels as it has grown. To serve these new channels, the company has partnered with several high-prof ile corporations, including PepsiCo, Dreyers, and Barnes " Noble. Starting with 17 stores in 1987, S tarbucks has grown to more than 1,000 stores. By the year 2000, the company hopes to have 2,000 loca tions. Starbucks is just beginning its international expansion, and plans to focus first on Asian ma rkets. Recent Stock Performance For the year ended September 29, 1996, total sales were $696.5 milli on and earnings were $92.1 million, representing an increase of 50% and 61% respectively over 1995 f igures. As of April 25, 1997, Starbucks' market capitalization was $2.15 billion. The chart below il lustrates the impressive rise of Starbucks' stock price relative to the Russell 1000 small-cap Index . The issue has routinely traded at 25 to 40 times earnings, and has been a high-growth favorite of many investors. From 1993 through 1996, the stock posted an annual equivalent gain of 32.6%. COMPETI TIVE ANALYSIS Once marketed as a commodity product like detergent or petroleum, coffee has become fo r North Americans, a very personal and highly distinctive consumption choice. In 1983, the specialty coffee industry represented less than 4% of the $6.5 billion US coffee market. In 1994, that market

share reached 31%. It is expected to hit 50% by the turn of the millennium. What once appeared to b e simply an interesting niche within a tired, margin-less industry, has grown into a food service ph enomenon rivaling the fast-food chains of the 1950's. Starbucks and competitors have effected a whol esale change in consumption patterns and redefined consumer tastes. The race is on to exploit this n ew market. According to the specialty Coffee Association of America, there will be approximately 10, 000 specialty coffee beverage outlets in the US by 1999. That's up from 4,000 at year-end 1994, and up from a mere 200 in 1989. In the midst of this explosive growth, the nature of tomorrow's competit ive forces are just beginning to take shape. Smart companies are defining their brands, erecting bar riers and positioning themselves vis-avie their competition in a frenetic rush to seize a solid foot hold in this new market. In his renowned 1979 Harvard Business Review article, Michael Porter states , "the nature and degree of competition in an industry hinge on five forces: the threat of new entra nts, the bargaining power of customers, the bargaining power of suppliers, the threat of substitute products or services, and the jockeying among current contestants." What follows is a brief overview of the competitive landscape emerging in the specialty coffee industry as seen through Porter's fiv e-forces lens. Rivalry Among Existing Firms Restaurants and Institutions. The popular business press have endearingly branded Starbucks the Juggernaut, the Goliath, and the 10,000 Pound Gorilla of spe cialty coffee. Such epithets imply a brutish, bigger-is-better mentality bent on crushing mom-and-po p. In reality, an interesting phenomenon is often observed when Starbucks opens shop in a new neighb orhood. To their surprise, local vendors frequently observe an increase in their own coffee sales. T he powerful Starbucks brand seems to capture new customers and educate them to the benefit of everyo ne in the industry. There will almost certainly be a shake out someday, but for now, the pie appears to be growing faster than competitors can slice it up. Concentration data support this view. Even i n the Pacific Coast, where the industry first took root, the market continues to grow. According to data supplied by the Restaurant Consulting Group in Evanston, Illinois, there are currently over 1,3 00 coffee bars in the region, with an additional 500 opening yearly. Newcomers are working hard to d ifferentiate themselves. To date, nobody has been able to approach Starbucks in size or market penet ration, and most seem reluctant to compete on those terms. Instead, competitors are focusing on diff erent nuances of the market in an effort to build brand identity. At the present time, most of these differentiation strategies hinge on service, location, or ambiance rather than product. Consumer ta stes (within the specialty coffee category) have not reached the sophistication of, for example, fin e wines. Unless this happens, the probable result over time will be lower and lower customer switchi ng costs, giving the competitive edge to coffee bars who have established solid brand identities. To ward that end, Barista Brava of Washington, DC uses proprietary equipment to speed the delivery of p roduct, giving them what they hope will be a competitive advantage in fast-paced locations like bus terminals, airports, and down-town business centers. Other coffee bars are seeking to differentiate themselves through such methods as adding more space to their designs, locating in shopping malls, a dding gourmet foods to the menu, and even providing on-site Internet connectivity. Those that can bu ild brand equity now, while the industry is young and fertile, will be the McDonalds and Burger King s of the future. Threat of New Entrants "Contributing to the intensity of the coming shake-out is th e fact that the business possesses exceedingly low barriers to entry"- Carol Casper for Restaurant B usiness Indeed, in some cases, it takes little more than four small walls or even a kiosk to deliver high quality coffee to the thirsty masses. The economies of scale are minuscule, even by food-servi ce standards. For companies able to compete on the mass level, brand advertising may take on more im portance and eventually present some economies of scale. This seems unlikely, however, to preclude s mall players from entering the industry on a local level. For the larger players, first mover advant age would seem a must. Accordingly, Starbucks has operated with a preemptive strategy, rolling out n ew stores and saturating existing markets as quickly as possible. Its goal: 2,000 North American uni ts by the year 2000. Industry wide, cafes and espresso bars are expected to grow to about 10,000 loc ations by 2000, according to the Specialty Coffee Association of Long Beach, California. Threat of S ubstitute Products "People try to classify us as a restaurant company or a specialty coffee company, but that focus is just too narrow. It's important to recognize that what we have built is one of th e most powerful consumer brands in North America."- Starbucks Chairman and CEO Howard Shultz in an i nterview with Nations Restaurant News. For the time being, it appears that specialty coffee is itsel f a substitute product, threatening to unseat established brands such as Folgers and Maxwell House. Like most consumer products, various types of foods have been known to fall into and out of fashion. Take, for example, the yogurt craze of the 1980's. Most industry analysts, however, see specialty c offee as an industry with considerable staying power. More than a fad product, an entirely new foodservice segment is taking shape. Furthermore, as a gathering place and an alternative to the bar sce ne, coffee bars fill a lifestyle need. Though it may be said there is no substitute for a good cup o f coffee, coffee bars are beginning to face significant substitution threat in the form of alternati ve distribution outlets. Bagel shops, in particular, have become adept at brewing a premium cup of c offee. With a similar ambiance and the added benefit of gourmet food, customers may be all too willi ng to switch. The increasing availability of specialty coffee at supermarkets offer another form of distribution to compete with baristas. This channel, in fact, is what Starbucks sees as its biggest competitive threat--and opportunity. Bargaining Power of Buyers "Because coffee consumption is habit ual, demand is inelastic. . . We do not think that a slight increase in the price of a cup of coffee will have a damaging effect on demand" - Craig Bibb, Paine Webber analyst. Buyers of coffee show a variety of price sensitivities. At the low price end, coffee is often considered a commodity and, ac cordingly, demonstrates price sensitivity. Buyers of Starbucks coffee, in contrast, have thus far sh own little price sensitivity. For example, a 1994 freeze in Latin America raised the prices of Arabi ca beans worldwide, which in turn put upward pressure on the prices of Starbucks coffee beverages. C

onsumers did not balk at the higher prices. The Starbucks brand stands for quality, and consumers ha ve shown great willingness to pay for that quality. In recent supermarket tests, Starbucks ground co ffee sold for $9.67 per pound. By comparison, Folgers and Maxwell ground sold for $3.08 and $3.55, r espectively. These brands, however, represent a lower end segment of coffee. It's likely that Starbu cks will attract competitors in the high end, with whom they may have to compete on price. Bargainin g Power of Suppliers "When other people go looking, they find that Starbucks' has already been there and picked off the best [locations], so how can you beat that?" -Roger Lipton, Principal, Lipton Fi nancial Services The major supply inputs of the specialty coffee industry are labor, real estate, an d coffee beans. With regard to labor, wage inflation of 3% to 5% is predicted for the next couple of years. Starbucks depends on a well-trained labor force to help run its retail outlets, and has, in fact, been hit recently by higher labor costs. In real estate, it's expected that quality sites will be harder to come by in established markets as the retail channel matures. Such a situation will pu t upward pressure on the price of highly desirable locations, as well as introduce a greater potenti al for cannibalization as markets saturate. As the demand for premium coffee continues to grow, so t oo will the demand for premium Arabica beans. Starbucks does not control this input. It is possible that there could be a modest shift in power toward bean suppliers. In addition, the supply of beans can be erratic due to poor growing seasons (i.e. crop freezes). STARBUCKS STRATEGY Starbucks is that rare business story: a company that has single-handedly breathed new life in an old commodity and e stablished a new "killer category." The product is coffee, and the category is high-end Java that si mply tastes better. Twenty-five years ago few US consumers drank premium coffee concoctions like lat tes--let alone pronounced them correctly. Today millions do. It's all part of a coffee-café trend th at Starbucks largely started. Unlike other food products that have enjoyed a fast but relatively sho rt-lived success (i.e. refrigerated yogurt), coffee is a daily staple and it is addictive. Since its inception in 1972, Starbucks has put together an impressive business model that has prompted shares to trade as high as 40 times earnings. Why the heightened optimism? Each Starbucks store has an ave rage of approximately $820,000 in revenues with a pre-tax margin of 17.5% after regional overhead al locations. Starbucks was a first mover in a largely fragmented industry and its strategy of focused differentiation-- premium coffee through specialty retail outlets--has put it well ahead of consumer products coffee providers (Proctor " Gamble, Kraft). No rival appears to seriously threaten its num ber one position in specialty coffee. As it has grown--the company has reported nine years of revenu e growth of 50% or more--Starbucks is becoming less of a specialty retailer than a major brand marke ter. The company is vertically integrated, controlling the purchasing, roasting and distribution of its coffee beans. Channels Starbucks has had great success in developing its channels of distributio n. Unlike many traditional consumer products companies, such as Proctor " Gamble, Starbucks did not develop its brand in the supermarket channel. Rather, Starbucks grew its reputation through companyowned retail outlets. These outlets, which combine company standards of design with location-specifi c tailoring, are the engines that have powered Starbucks' growth. Today, though, Starbucks is levera ging its highly recognized coffee brand in a much wider web of channels: 1) Retail outlets - traditi onal outlets of two general sizes. The larger of the two costs approximately $315,000 for start-up, the smaller about $250,000. 2) Licensee outlets - Of the 1,107 retail stores at the close of 1996, o nly 80 were licensed. Marriot International is the primary licensee, selling Starbucks coffee mainly through airport kiosks. 3) Mail-order - Customers wanting to make Starbucks coffee at home have tra ditionally bought beans through either the retail outlet or mail-order catalogs. Taken together, athome consumption of beans comprised $114 million in sales last year. 4) U.S. Office Products - Starb ucks coffee has been recently added to the U.S. Office Products catalog to allow businesses to order Starbucks whole and ground beans. 5) Airlines - Starbucks is the coffee of choice on every United a nd Alaska Airlines flight. United Airlines serves 75 million passengers a year. 6) Concept outlets Starbucks is working with Intel to develop "cyber-cafes." 7) Other retail formats - Breves (165 sq. feet) and Doppios (70 sq. feet) are compact formats that have minimal real estate requirements. 8) Bookstores - Both Barnes " Noble and, more recently, Canada's Chapters sell Starbucks coffee in thei r bookstore cafes. 9) Other retail partners - ITT Sheraton (60 hotels), Nordstrom (70 stores) and Pr iceCostco (240 member stores) all serve or carry Starbucks coffee. 10) Supermarkets - No channel rep resents as much opportunity as this one. The 1996 supermarket sales of coffee was $3.16 billion, led by Proctor " Gamble's Folgers ($877 million) and Kraft General Foods' Maxwell House ($800 million). This fiscal year Starbucks is expected to approach the market leaders in coffee revenues--without a supermarket presence. Recent test-marketing has been very encouraging, with Starbucks coffee outsel ling Folgers 3 to 1 at a 213% price premium. Depending on its supermarket penetration, and if test-m arket sales rates apply nationally, Starbucks management estimates that supermarket sales of Starbuc ks whole and ground beans could range from $200 million (50% penetration) to $400 million (100% pene tration). Establishing this channel will require significant managerial expertise and financial reso urces, however. Advertising--currently 36 percent of store revenues--is expected to increase in orde r to support the selling in supermarkets. Because the vast majority of Starbucks franchises are comp any-owned, the company has been able to extend its channel breadth without the vexing political prob lem faced by many quick-serve restaurants: alienating independent franchise owners. Without this hur dle, Starbucks can continue increasing its reach in rapid fashion. But, unlike a McDonalds or a Wend y's, Starbucks has a brand image that might limit the number of retail outlets it can open, and the number of channel partners it might consider. To what degree a stand-alone Starbucks retail outlet w ould "work" along the lonely Interstate to Podunk, PA is questionable. Moreover, it's doubtful wheth er Starbucks would ever risk diluting the brand image by selling its coffee through Interstate roadstops, where patrons can buy both gas and quick-service food. Benchmarking Starbucks against many of the traditional quick-service players, therefore, is often unwieldy. The proliferation of channels

also brings to bear questions of cannibalization, and the extent to which management estimates--in p articular with the supermarket sales-- consider this problem. Channel cannibalization is easy to vis ualize, but its overall effect is difficult to predict. For instance, how will sales through U.S. Of fice products (workplace coffee) affect the sales of the many neighboring urban retail franchises? H ow will supermarket sales affect the customary morning trip to Starbucks? The company will clearly n eed to monitor these effects as it establishes its claim on the overall share of the coffee market. Product Diversification Starbucks sells more than just coffee. At its retail outlets, the company of fers bakery goods, confections, and coffee-related equipment and merchandise--much of which is carri ed through its mail-order channel as well. The company outsources its bakery offerings to local vend ers, who must comply with Starbucks quality standards. Bakery product sales at Starbucks is still re latively modest and represents an opportunity for the company going forward. Moreover, to increase c ustomer traffic beyond the morning hours, the company is experimenting with lunch offerings and dess erts (i.e. milk shakes). Starbucks' track record with new products spans the spectrum. One product c alled Mazagran is moribund, having generated a paltry $87 dollars of sales last December-- enough to buy a couple of high-end espresso machines for resale. On the flip side, bottled frappuccino (joint venture with PepsiCo) and Starbucks-branded ice cream (joint venture with Dreyers) have done except ionally well in supermarkets. Starbucks will roll out its bottled frappuccino nationally this summer , and, once fully distributed, the company predicts it will achieve $90 to $100 million in annual sa les (currently 10% supermarket penetration). Ice-cream represents an additional potential of $40 mil lion. Having Pepsi and Dreyers as joint partners will enable rapid supermarket penetration for these two products. Human Resources The company has put together a motivated work force. Turnover at Star bucks in only 60% compared with the quick-service food average of 140%. Not only are the retail work ers well-trained--workers must take 24 hours of "coffee education"--but all full-time and part-time employees also receive health care benefits and stock option benefits. Industry followers, meanwhile , consider Starbucks' management team to be highly capable. Retail Outlets Starbucks plans to increa se the number of retail outlets from 1,100-plus at the beginning of 1997 to 2,000 stores by the year 2000. Where will the growth occur? The company has opportunities both domestically and internationa lly. Domestically, Starbucks is quickly becoming a fixture in most large urban cities. North America n Market: Despite this year's nearly store-a-day rate of opening, Starbucks has not finished growing its North American base. It plans to focus on Phoenix and Miami in 1997--on the heels of developing new markets last year in North Carolina, Idaho, and Toronto. Last December, Starbucks opened its fi rst retail outlet in Hawaii and plans to have 30 by 1998. In Georgia, only Atlanta has Starbucks sto res (six). Sales growth in existing stores is predicted to be 3% to 6% over the next few years. This estimate, though, contradicts the expectation that the overall average sales at existing stores wil l drop. That is, with each store opening in a developed market, the sixth store will not likely gene rate the same sales levels as the first store in that market. International Market: At the end of 19 96, Starbucks had only seven international retail locations. As a gross comparison, McDonalds has 7, 012 international units, KFC 4,526, Pizza Hut 3,245, Baskin-Robbins 1,680 and Subway Sandwiches 1,32 6. All told, McDonalds derives nearly half of its revenues from international units. Starbucks has o pted to grow its international sales at a slow and steady rate, starting with Japan, the third large st coffee market in the world. Through a joint-venture with SAZABY, a Japanese retailer and restaura nteur, the company opened three units last January. Initial demand has been strong, and Starbucks an ticipates opening 12 stores in Tokyo by 1998. Singapore is another market on the Starbucks radar scr een. In the next year or so, the company wants to open 10 stores there. Long-term international expa nsion also includes Australia and Europe. Indeed, the potential to increase sales internationally se ems enormous. Nevertheless, there's some question as to whether certain countries will accept a Star bucks as a coffee place of choice. Coffee houses have a rich background in countries like Italy and Turkey. The idea of Starbucks, in fact, came from observing Italian baristas. Managing a foothold in places with a rich coffee heritage might prove very difficult. ACCOUNTING ANALYSIS Discussion of Ke y Items in Financial Statements Income Statement n Strong Sales Growth and Unit Growth For the years 1992 to 1996, total sales volume grew at an annualized rate of 61.2% and units grew at a rate of 57 .1%. n Consistent Sales Mix: To date, the vast majority of sales have come from retail units (86.2%) , specialty sales (11.3%), and direct response sales (2.5%). This pattern has consistently prevailed over the previous three years. However, as Starbucks continues its build its brand through new chan nels and as the retail chain begins to mature, this mix may change. n Decrease in Comparable Sales G rowth Rate: This rate has decreased from a high in 1992 of 19% to 7% in 1996. n Consistent Cost of G oods Sold: During the period, these costs have consistently been in the range of 77.5% to 79%. n Dec reasing SGA Expense: Since 1992, this expense has decreased from 11.5% to 8.2%. Given that many of t hese expenses are fixed, this observation is consistent with a high growth company. Balance Sheet n Large Balance in Cash and Marketable Securities: As of 9/29/96, approximately 31% of the company's t otal assets were in cash and marketable securities. This amount is high due to the fact that the com pany has recently completed a debt offering and has yet to deploy the capital. Therefore, it is not expected to continue at these levels. n Low Debt Levels: The debt in the capital structure consists entirely of 4.50% redeemable, convertible debt. Furthermore, with the stock trading and $28.00 and a conversion price of $23.00, the debenture is in the money. n Inventory Levels Have Fluctuated: Desp ite the dramatic increases in growth during the previous five years, inventory levels, both as a per centage of sales and as a percentage of assets, have fluctuated considerably. While no explanation i s given for this trend in the footnotes, Starbucks' commitment to purchasing the highest quality pro duct and the price fluctuations that have historically plagued the coffee market may prohibit a cons istent implementation of purchasing policy. Statement of Cash Flows n Cash Flow From Operations is C onsistently Positive: Since 1994, CFO has grown consistently, but with the exception of 1996, it has

significantly lagged net income. In 1996, the $136,679 is composed primarily of the reduction in in ventory ($40,274) and the increase in depreciation ($39,370). Given the inconsistent inventory polic y discussed above, it is uncertain that this source of cash will continue in the future. n Cash Flow From Investing is Consistently Negative: Given the growth nature of the company, this should come a s no surprise. Capital expenditures and marketable securities are the primary uses of cash raised in the market. n Cash Flow From Financing: Funds have come from two primary sources: an equity offerin g of $165M in 1995 and a convertible debenture offering of $165M in 1996. While the company's appeti te for capital in the future is unquestioned, the company has not revealed its preferred source for growth. However, given the high market capitalization, the company has ample debt capacity should it choose to raise it. Statement of Shareholders' Equity n Zero Dividend Payout: No dividends have bee n paid. n Stock Options are Prominent Part of the Compensation Package: Starbucks considers its peop le to be a key component of its success formula. Stock options are a key part of the compensation st rategy. A review of the notes to the financial statements reveal that, as of 9/29/96, there are 7,64 2,379 options outstanding. The exercise prices range from $0.75 to $26.94. Notes to the Financial St atements n Significant Commitments to Operating Leases: Currently, Starbucks has future operating le ase commitments of $364,740. As Exhibit 4 illustrates, these leases, when capitalized at the after t ax cost of debt, equal a present value of $281,970. n Joint Ventures and Equity Investments: These e fforts include branding initiatives with companies such as Dreyer's Grand Ice Cream, PepsiCo, and SA ZABY (a Japanese retailer and restauranteur). While this amount is currently small (4.4mil) it is ex pected to grow significantly in the future as the company pursues similar brand extension opportunit ies. n Divestiture of Noah's Bagels: In 1996, the company divested its share of a joint venture in N oah's Bagels, which was initially undertaken with Boston Chicken. Not only did this action produce c ash for the firm, but it also signaled Starbucks' desire to focus on its core business. n No Signifi cant Litigation: The company is not a party in any legal actions. Ratio Analysis: Profitability and Productivity In addition to the Du Pont analysis discussed later in this paper, the following discus sion is designed to examine the historical performance of Starbucks. Asset Management Given the cash nature of the retail business, which makes up the vast majority of Starbucks' business, accounts re ceivable is a very small amount on the balance sheet. Thus, the high A/R balances should not be give n great weight. Likewise, it is difficult to draw solid conclusions about the firm's ability to mana ge its inventory. While calculations with both ending and average balances indicate that the firm's management practices have been inconsistent, the extent of the swings is uncertain. As discussed in the paper, the volatility in coffee prices and the firm's commitment to the highest quality products may prevent the firm from implementing an inventory policy. The rapid pace of sales growth also mak es interpretation difficult. Fixed Asset Inventory has consistently declined since 1993. This seems logical given the company's commitment to growth. For instance, while 100% of the fixed assets are i ncluded on the books when the new stores are opened, many of the stores will have only a few months worth of sales. As new store openings intensify (over 300 last year), this effect will decrease the overall fixed asset turnover, even though store comparables are growing. Asset Management Ratios 199 6 1995 1994 1993 AR Turnover (AVG) 50.70 61.03 67.11 75.64 Days Receivable Outstanding 7.18 5.96 5.4 2 4.90 Inventory Turnover (AVG) 5.28 4.01 5.37 7.27 Inventory Turnover (END) 6.56 2.91 3.93 5.28 Day s Inventory Out. (END) 68.95 90.84 67.75 51.02 Fixed Asset Turnover 2.27 2.41 2.69 3.38 Profitabilit y Ratios Profitability is improving on an annual basis. Cost of goods sold is the major expense comp onent on the income statement and has consistently remained in the 77% - 78% range. This would seem to confirm that the business model for store growth works. SGA has consistently decreased over time. Given the fixed component of this cost, this should come as no surprise. Profitability Ratios 1996 1995 1994 1993 Return on Sales 6.80% 6.10% 4.40% 5.50% COGS% 78.46% 77.40% 77.36% 77.67% SGA% 8.19% 9.15% 10.06% 11.38% Income tax Expense % 1.25% 0.81% 1.34% 0.44% Debt and Interest Coverage While th e firm has convertible debt outstanding, this amount is not included in the calculation of historica l ratios. Indeed, given that the existing convertible debt is currently in the money, this a logical exclusion. However, the interest payments associated with the debentures are included for purposes of cstarbucks coffee overvalued stock despite strong growth prospects business analysis security val uation prepared erik eselius taylor olivier boekhorst peter winters professor charles johnson gradua te school management cornell university april table contents table executive summary overview starbu cks business recent stock performance competitive analysis rivalry among existing firms threat entra nts threat substitute products bargaining power buyers bargaining power suppliers starbucks strategy channels product diversification human retail outlets accounting analysis discussion items financia l statements ratio profitability productivity earnings bankruptcy prediction valuation forecasts lon g term growth rate cost equity dividends target stock value discounted cash flow cost capital sales drivers capital expenditures terminal valu comparables cross sectional pont market multiples recomme ndation executive summary according popular turkish proverb coffee should black hell strong death sw eet love coffee company seattle washington also rich gold well managed aggressive company that achie ved heady growth since inception company earned place business history innovative firstmover brand s ynonymous with quality nevertheless after conducting wide range qualitative quantitative analyses ma rket enthusiasm that runneth over april closed discounted cash flow model using baseline assumptions cost capital sales generated price most aggressive scenario produced price most conservative case p roduced impressive with first rate products services minds overvalued recommendation long short arri ving recommendation used several analyses techniques after overview began with competitive that uses five force framework discuss specialty industry then analyzed strategy followed discussion accounti ng valuation accounting includes beneisch model score discussion items financial statement competiti ve pont ratio section comprises market multiples overview sells premium beverages beans through owne d licensed retail outlets stated objective establish most recognized respected brand world through r

etail outlets seattle based also sells bakery goods confections equipment merchandise expanded both product line marketing channels grown serve these channels partnered several high profile corporatio ns including pepsico dreyers barnes noble starting stores grown more than stores year hopes have loc ations just beginning international expansion plans focus first asian markets recent performance yea r ended september total sales were million earnings were million representing increase respectively over figures april capitalization billion chart below illustrates impressive rise price relative rus sell small index issue routinely traded times earnings been high favorite many investors from throug h posted annual equivalent gain once marketed commodity product like detergent petroleum become nort h americans very personal highly distinctive consumption choice specialty industry represented less than billion share reached expected turn millennium what once appeared simply interesting niche with in tired margin less industry grown into food service phenomenon rivaling fast food chains competito rs have effected wholesale change consumption patterns redefined consumer tastes race exploit this a ccording specialty association america there will approximately beverage from year from mere midst t his explosive nature tomorrow forces just beginning take shape smart companies defining their brands erecting barriers positioning themselves avie their competition frenetic rush seize solid foothold this renowned harvard review article michael porter states nature degree competition hinge five forc es threat entrants bargaining power customers suppliers substitute products services jockeying among current contestants what follows brief landscape emerging seen porter five forces lens rivalry amon g existing firms restaurants institutions popular press have endearingly branded juggernaut goliath pound gorilla such epithets imply brutish bigger better mentality bent crushing reality interesting phenomenon often observed when opens shop neighborhood their surprise local vendors frequently obser ve increase powerful brand seems capture customers educate them benefit everyone there will almost c ertainly shake someday appears growing faster than competitors slice concentration data support view even pacific coast where first took root continues grow according data supplied restaurant consulti ng group evanston illinois there currently over bars region additional opening yearly newcomers work ing hard differentiate themselves date nobody been able approach size penetration seem reluctant com pete those terms instead competitors focusing different nuances effort build identity present time t hese differentiation strategies hinge service location ambiance rather consumer tastes within catego ry reached sophistication example fine wines unless happens probable result time will lower lower cu stomer switching costs giving edge bars established solid identities toward barista brava washington uses proprietary equipment speed delivery giving them what they hope advantage fast paced locations like terminals airports down town centers other bars seeking differentiate themselves such methods adding more space designs locating shopping malls adding gourmet foods menu even providing site inte rnet connectivity those build equity while young fertile mcdonalds burger kings future entrants cont ributing intensity coming shake fact possesses exceedingly barriers entry carol casper restaurant in deed some cases takes little more four small walls even kiosk deliver high quality thirsty masses ec onomies scale minuscule food service standards companies able compete mass level advertising take im portance eventually present some economies scale seems unlikely however preclude small players enter ing local level larger players mover advantage would seem must accordingly operated preemptive strat egy rolling stores saturating existing markets quickly possible goal north american units wide cafes espresso expected grow about locations association long beach california substitute people classify restaurant focus just narrow important recognize built powerful consumer brands north america chair man howard shultz interview nations news time being appears itself threatening unseat established br ands such folgers maxwell house like various types foods been known fall into fashion take example y ogurt craze analysts however considerable staying entirely segment taking shape furthermore gatherin g place alternative scene fill lifestyle need though said good beginning face significant substituti on form alternative distribution bagel shops particular become adept brewing premium similar ambianc e added benefit gourmet customers willing switch increasing availability supermarkets offer another form distribution compete baristas channel fact sees biggest opportunity buyers because consumption habitual demand inelastic think slight increase damaging effect demand craig bibb paine webber analy st buyers show variety sensitivities often considered commodity accordingly demonstrates sensitivity contrast thus shown little sensitivity example freeze latin america raised prices arabica beans wor ldwide which turn upward pressure prices beverages consumers balk higher prices stands quality consu mers shown great willingness recent supermarket tests ground sold pound comparison folgers maxwell g round sold respectively these however represent lower segment likely attract whom they suppliers whe n other people looking they find already picked best beat roger lipton principal lipton financial se rvices major supply inputs labor real estate beans regard labor wage inflation predicted next couple years depends well trained labor force help fact recently higher costs real estate expected sites h arder come established markets channel matures situation upward pressure highly desirable well intro duce greater potential cannibalization saturate demand premium continues grow arabica does control i nput possible could modest shift toward bean addition supply erratic poor growing seasons crop freez es rare story single handedly breathed life commodity killer category category java simply tastes be tter twenty years consumers drank concoctions lattes alone pronounced them correctly today millions part trend largely started unlike other enjoyed fast relatively short lived success refrigerated yog urt daily staple addictive since inception together impressive model prompted shares trade times hei ghtened optimism each store average approximately revenues margin after regional overhead allocation s mover largely fragmented focused differentiation ahead providers proctor gamble kraft rival appear s seriously threaten number position reported nine years revenue becoming less retailer major market er vertically integrated controlling purchasing roasting distribution great success developing unlik e many traditional companies proctor gamble develop supermarket channel rather grew reputation owned which combine standards design location specific tailoring engines powered today though leveraging

highly recognized much wider traditional general sizes larger costs approximately start smaller abou t licensee close only were licensed marriot international primary licensee selling mainly airport ki osks mail order wanting make home traditionally bought either outlet mail order catalogs taken toget her home comprised million last office recently added office catalog allow businesses order whole gr ound airlines choice every united alaska airlines flight united airlines serves passengers concept w orking intel develop cyber cafes formats breves feet doppios feet compact formats minimal real estat e requirements bookstores both barnes noble recently canada chapters sell bookstore cafes partners s heraton hotels nordstrom pricecostco member serve carry supermarkets represents much opportunity sup ermarket billion proctor gamble folgers kraft general foods maxwell house fiscal approach leaders re venues without presence test marketing very encouraging outselling depending penetration test rates apply nationally management estimates whole could range penetration establishing require significant managerial expertise resources advertising currently percent store revenues support selling superma rkets because vast majority franchises owned able extend breadth without vexing political problem fa ced many quick serve restaurants alienating independent franchise owners without hurdle continue inc reasing reach rapid fashion unlike mcdonalds wendy image might limit number open number partners mig ht consider degree stand alone outlet would work along lonely interstate podunk questionable moreove r doubtful whether would ever risk diluting image selling interstate road stops where patrons both q uick benchmarking against traditional quick players therefore often unwieldy proliferation also brin gs bear questions cannibalization extent which management estimates particular consider problem cann ibalization easy visualize overall effect difficult predict instance office workplace affect neighbo ring urban franchises affect customary morning trip clearly need monitor effects establishes claim o verall share diversification sells offers bakery goods confections related equipment merchandise muc h carried mail outsources bakery offerings local venders must comply standards still relatively mode st represents opportunity going forward moreover customer traffic beyond morning hours experimenting lunch offerings desserts milk shakes track record spans spectrum called mazagran moribund having ge nerated paltry dollars last december enough couple espresso machines resale flip side bottled frappu ccino joint venture pepsico branded cream joint venture dreyers done exceptionally roll bottled frap puccino nationally summer once fully distributed predicts achieve annual currently cream represents additional potential having pepsi dreyers joint partners enable rapid human resources together motiv ated work force turnover only compared average only workers trained workers must hours education ful l part employees receive health care benefits option benefits followers meanwhile consider team capa ble plans plus where occur opportunities domestically internationally domestically quickly becoming fixture large urban cities american despite nearly store rate opening finished growing american base plans focus phoenix miami heels developing last carolina idaho toronto december opened outlet hawai i georgia atlanta predicted next estimate though contradicts expectation overall average drop each o pening developed sixth likely generate same levels international seven gross comparison mcdonalds un its pizza baskin robbins subway sandwiches told derives nearly half units opted slow steady starting japan third largest world venture sazaby japanese retailer restauranteur opened three january initi al strong anticipates tokyo singapore another radar screen next wants open term expansion includes a ustralia europe indeed potential internationally seems enormous nevertheless some question whether c ertain countries accept place choice houses rich background countries italy turkey idea came observi ng italian baristas managing foothold places rich heritage might prove very difficult items statemen ts income statement unit total volume grew annualized grew consistent date vast majority come direct response pattern consistently prevailed previous three continues build chain begins mature change d ecrease comparable decreased consistent goods sold during period consistently range decreasing expen se since expense decreased given expenses fixed observation consistent balance sheet large balance c ash marketable securities total assets marketable securities amount completed debt offering deploy t herefore continue levels debt levels debt structure consists entirely redeemable convertible further more trading conversion debenture money inventory fluctuated despite dramatic increases during previ ous inventory percentage percentage assets fluctuated considerably while explanation given trend foo tnotes commitment purchasing highest fluctuations historically plagued prohibit implementation purch asing policy statement flows flow operations consistently positive exception significantly lagged in come composed primarily reduction inventory depreciation given inconsistent policy discussed above u ncertain source continue future investing negative nature should come surprise expenditures marketab le securities primary uses raised financing funds primary sources equity offering convertible debent ure offering while appetite future unquestioned revealed preferred source capitalization ample capac ity should choose raise shareholders zero dividend payout dividends paid options prominent part comp ensation package considers people component success formula options compensation review notes statem ents reveal options outstanding exercise notes significant commitments operating leases operating le ase commitments exhibit illustrates leases when capitalized equal present value ventures investments efforts include branding initiatives dreyer grand cream pepsico sazaby japanese retailer restaurant eur amount significantly pursues similar extension opportunities divestiture noah bagels divested sh are noah bagels initially undertaken boston chicken action produce firm signaled desire core litigat ion party legal actions ratio profitability productivity addition pont discussed later paper followi ng designed examine historical performance asset makes vast majority accounts receivable amount bala nce sheet thus balances great weight likewise difficult draw solid conclusions about firm ability ma nage calculations ending balances indicate firm practices inconsistent extent swings uncertain discu ssed paper volatility commitment highest prevent implementing policy rapid pace makes interpretation fixed asset declined logical commitment instance fixed assets included books opened months worth op enings intensify effect decrease asset turnover comparables ratios turnover days receivable outstand ing days profitability ratios improving annual basis major expense component income remained seem co

nfirm works decreased component surprise ratios return cogs interest coverage convertible outstandin g included calculation historical indeed money logical exclusion interest payments associated debent ures included purposesEssay, essays, termpaper, term paper, termpapers, term papers, book reports, s tudy, college, thesis, dessertation, test answers, free research, book research, study help, downloa d essay, download term papers