Starbucks Bull's Pen
by Bill Barker ([email protected])

When the Fool Portfolio announced its intent to add Starbucks at a price of about $53 a share, a then P/E of roughly 65, perhaps the buy report should have included an echo of the litigation-inspired warning that adorns every cup of the Seattle-based retailer's coffee: "Careful, the stock we're about to enjoy is extremely hot."

After that buy report was announced, a little additional froth was added on top, and the shares quickly peaked at a mere 1/16 shy of $60 per share. However, the recent 3Q earnings report, though announcing earnings per share in line with estimates, did not include an announcement of the split expected by some. Then Starbucks announced July same-store sales that were only two percent better than the year before. The stock has cooled back down, and now even my bearish opponent Edible will have to admit that at a recent price below $42 per share, this world-beating coffee retailer's stock is much more... Potable?

The reasons that make this stock look so attractive for the foreseeable future are almost as numerous as its 1800+ retail locations. Virtually all the arguments in favor of Starbucks are mentioned in far greater detail in the outstanding Fool buy report, which is incorporated by reference as if set forth at length herein. (Lawyerspeak. It means my argument now gets as much credit for the entire 20-page report as if I'd written the whole thing myself.)

To start with, the most obvious reason to expect continued market-beating performance is that Starbucks is the leading purveyor of retail coffee drinks in the country, and it already seems to be serving people (read: addicts) on a daily and repeating basis everywhere you look. From the classic coffees and cappuccinos, to the summer sales-boosting Frappuccinos, to the new blended juiced tea Tiazzi, Starbucks is in a lot of hands and on a lot of desks. Even those annoying little fold-down airline trays have a lot of steaming Starbucks precariously balanced over people's laps (yikes!), as both United Airlines <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: UAL)") else Response.Write("(NYSE: UAL)") end if %> and Canada Airlines have struck deals to serve Starbucks.

The deals aren't just covering the friendly skies, though. For those who have trouble staying awake while pretending to buy books or while banking, Barnes and Noble <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BKS)") else Response.Write("(NYSE: BKS)") end if %> and Wells Fargo Bank <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WFC)") else Response.Write("(NYSE: WFC)") end if %> now serve Starbucks. They are only two of the corporate giants that find it profitable to make sure that you're never too far from that extra-caffeinated jolt that has so many cheerful patrons saying not, "I'd like some coffee," but rather "I need my Starbucks." (This, actually, is usually growled.)

However, the brand isn't only about retail coffee service. Starbucks is the leader in premium coffee-flavored ice cream as well, courtesy of a deal with Dreyer's Grand Ice Cream (NASD: DRYR). Further, thanks to a venture with PepsiCo <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PEP)") else Response.Write("(NYSE: PEP)") end if %>, Starbucks-bottled Frappuccinos now dominate the ready-to-drink coffee category with 90% of the U.S. market share. Packages of whole bean coffee with the nautical bare-breasted siren on the outside are also in 3,500 supermarkets in the western U.S. Ubiquity, thy name is Starbucks.

But, some are wondering, doesn't this mean that the major growth is already over? Once Starbucks is on every other block in every major city, as it already seems to be, where does the next Starbucks open? In the rest room of an existing Starbucks? (This one's actually worth clicking into.) Hardly. Currently, Starbucks has less than a 5% share of the North American coffee market, and less than a 1% share of the foreign coffee market, so there's tremendous opportunity to grow for a long time. For instance, a small out-of-the-way place known as "continental Europe" currently has no Starbucks. For that matter, neither does South America, Africa, or the Middle East. Or most of Asia.

In fact, not much of the world knows anything about Starbucks. Yet. Analysts expect earnings growth to come at a 33% rate over the next five years courtesy of further unit expansion in the U.S. (5000 domestic units is the long-range target), and more importantly, expansion into the great wide world beyond North America's shores. While Starbucks currently has fewer than 100 locations internationally, over 500 are expected in both Europe and Asia by the year 2003. Next year Starbucks will be opening at least 400 new stores in North America, and another 100 internationally.

Rick will tell you that the consensus 5-year earnings growth expectations of 33% are properly categorized as somewhere between "aggressive" and "silly." I'll give him that, and not because of the July numbers -- current sales growth just doesn't support that kind of projection over five years. But a real growth rate in the upper 20s is certainly achievable for a company that has barely scratched the surface of its potential around the world and has yet to stumble in the execution of its business plan.

If Starbucks achieves the roughly $1.22 in earnings per share predicted for FY '99, and then grows at a comparatively conservative 28% rate for the four years following, that would give Starbucks earnings per share of $3.30 in FY 2003. Considering that this company historically trades at a P/E multiple significantly higher than its projected growth rate, however you do the math, that makes for an awfully good investment at today's price.

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