STARBUCKS Valuation Model by Varun Gadia

M. J. NEELEY SCHOOL OF BUSINESS EDUCATION INVESTMENT FUND SESSION: SPRING 2015 ANALYST: VARUN GADIA STARBUCKS

HOLD

SUMMARY TICKER

SBUX

SECTOR

FOOD SERVICES

INDUSTRY

CONSUMER DISCRETIONARY

CLASSIFICATION

CAPITAL APPRECIATION

RECENT PRICE

$92.22

52 WEEK PRICE RANGE

$68.73‐$94.55

2014 EPS

2.75

CURRENT P/E

31.61

2017 P/E

27.50

CURRENT DIV. YEILD

1.46%

BETA

0.87

DEBT RATING [MOODY’S]

A3 [STABLE OUTLOOK]

STARBUCKS VALUATION (SPRING 2015) 1

PROS

CONS

 MARKET CONSOLIDATION

 SLOW WORLD GDP GROWTH

 CHINA & ASIA PACIFIC (CAP) EXPANSION

 SUPPLY CHAIN RISKS IN CAP REGION

 JAPANESE ACQUIZITIONS

 RAPID RISING AND THRIVING COMPETITORS

 INCREASE IN TICKET SIZE

 RISK OF FAILURE IN GROWTH STRATEGIES

 INCREASE IN COMPARABLE STORE SALES

 LOWER OPERATING MARGINS

 STRONG DOLLAR

PORTERS FIVE FORCES THREAT OF COMPETITION

HIGH

THREAT OF NEW ENTRANTS

MODERATE

THREAT OF SUBSTITUTES

MODERATE

THREAT OF SUPPLIERS

MODERATE

THREAT OF BUYERS

LOW

COMPANY OVERVIEW

Starbucks purchases and roasts high quality whole coffee beans and offers selection of premiums teas, pastries and other delectable treats to please the taste buds. The irm focuses on creating outlets which act as places in which people can chat, meet up or even work. Starbucks is a neighborhood gathering place— a part of a persons daily routine. Starbucks is the world’s #1 specialty coffee retailer. The irm has over 21,000 locations in 65 counties. In the US the irms outlets are primarily company owned and outside the US the irm operates through self‐owned and licensing models. The irm’s primary product is coffee, but it aims to expand to other products such as tea, juices, food, and wine. The irm has two major segments that are the restaurant segment and the channel development segment. The restaurant segment can be further classi ied by geography into Americas, Europe –Middle East ‐ Africa (EMEA) and the China‐ Asia ‐ Paci ic (CAP) regions. Starbucks operates various brand that include Coffee Brands such as Starbucks Coffee and Seattle’s Best Coffee, Tea brands such as Tevana and Tazo, Juice brand Evolution Fresh, and Food brand La Boulange. Moreover, the irm focuses on providing its services through the lens of humanity. The irm exhibits these facets in the ways through which they engage with their customers and communities. Overall, Starbucks is a irm which is focused on providing an experience when it comes to drinks and food. Starbucks, aims to be a global brand recognized for it’s coffee and tea leadership, technological integration, employee satisfaction and global presence.

STARBUCKS VALUATION (SPRING 2015) 2

ORIGINAL PURCHASE RATIONALE

Starbucks was originally purchased on October 31, 2012 to reduce the Fund’s exposure to the clothing and footwear manufacturing and retailing industry in the Consumer Discretionary sector. At that time, the EIF held VF Corp (VFC), Lu‐ lulemon Athletica Inc. (LULU), and Wolverine World Wide (WWW). Today, the EIF holds Disney, Delphi Automotive, VF Corp, and Starbucks in the Consumer Discretionary sector. PORTFOLIO CONSIDERATIONS

Since October 31, 2012 Starbucks has returned the EIF 108.24% and the XLY (Consumer Discretionary Spider) has re‐ turned us 69.24%. YTD Starbucks has returned 13.64% and the XLY has returned 5.28%. The S&P in our holding period has returned 54.26% and YTD has returned 1.02%. Starbucks has shown a lack lustered 2013 growth but has strong 2014 growth. The company is expected to continue its strong performance over the next 3 years. Starbucks has a lower correlation compared to the other stocks in the consumer discretionary sector. Starbucks even has a lower correlation with indices in premier regions the irm performs operations, such as United States, Europe & Japan.

SECUIRTY SBUX DLPH VFC DIS XLY SPX SX5E NKY

CORRELATION MATRIX [CONSUMER DISCRETIONARY] SBUX DLPH VFC DIS XLY SPX SX5E 1.00 0.44 1.00 0.40 0.42 1.00 0.46 0.49 0.41 1.00 0.65 0.68 0.61 0.77 1.00 0.58 0.68 0.59 0.69 0.91 1.00 0.35 0.41 0.29 0.43 0.51 0.58 1.00 0.05 0.12 0.12 0.12 0.09 0.10 0.17

NKY 1.00

Overall, due to a lower correlation, strategic expansions, strong and noteworthy acquisitions, higher consumer discre‐ tionary spending, and larger product mix, I strong recommend a hold for Starbucks.

INDUSTRY OVERVIEW Starbucks is a part of the Coffee and Snack Shop Industry (CSS). This industry has reached the maturity stage in the Unit‐ ed States. Therefore, big companies like Starbucks, Dunkin’ Brands, Krispy Kreme, etc. are focusing on international ex‐ pansion to increase and diversify their market share. Internationally, this industry is in the growth stage providing com‐ panies an opportunity to enter into a new market and become global market leaders by leveraging their industry knowledge and economies of scale. Over the past ive years, CSS has been buoyed by increased consumer spending, driven by higher disposable incomes and greater con idence in the economic outlook. The industry was hit hard by the recession as unemployment rose, consumer con idence tanked and spending dried up. However, CSS has rebounded from the recession at a faster rate than most seg‐ ments of the food service sector as consumers increasingly seek convenience at an affordable price.

STARBUCKS VALUATION (SPRING 2015) 3

The industry has had to adapt to changing consumer preferences over the past ive years, especially those relating to health and diet. Consumers have become increasingly health conscious and are avoiding foods that are high in fat and salt content. Some irms have responded to this trend by expanding the number of healthy options on their menus. A few trends have been noteworthy in the industry. These are ‐ 1. Product Mix and Offerings ‐ Firms have been expanding their product offerings to include alternatives drinks such as juices ad tea’s, and breakfast offerings such as wraps, pastries and sandwiches. 2. Store Offerings ‐ Firms have been adopting to new store formats such as drive through stores, highways, reserve stores and tasting rooms. Firms have been renovating older stores in line to newer and richer interiors preferred by customers. 3. International Expansion ‐ Firms are investing further international growth as part of their long‐term strategy, because irms view emerging economies as markets with huge potential for growth and long‐term pro itability. 4. Technology Adoption ‐ Firms have leveraged mobile and online technology in their payment systems and their supply chains. These strategies have helped increase purchases, customer retention, and operating margins.

INDUSTRY BREAKDOWN

INDUSTRY BREAKDOWN COFFEE SHOPS

42%

OTHER SNACK SHOPS

21%

DONUT SHOPS

15%

ICE CREAM SHOPS

13%

BAGEL SHOPS

FROZEN YOGURT SHOPS

COOKIE SHOPS

1. Coffee Shops ‐ Coffee Shops are the largest contributor to this industry. The demographic is the same across the US and the EMEA. However, as the consumption of Coffee increases so does the consumption of other snacks. In the coming years, coffee shops will continue to have an advantage over other shops, but the trend will shift towards reserve and spe‐ cialty coffee’s. 2. Donut Shops ‐ Donut shops are the second largest contributor to this industry. The number of donut shops has been decreasing and will continue to decrease in the US. However, as the irms compete globally in which the industry is in the growth phase these shops will still be a prominent part of the industry 3. Ice Cream Shops ‐ These shops form the third largest contributor to this industry. Ice cream shops have been facing decreasing revenue due to health considerations. Ice cream shops have been loosing revenue to Frozen Yogurt options.

STARBUCKS VALUATION (SPRING 2015) 4

4. Frozen Yogurt & Cookie Shops ‐ These shops have been a growing trend in this industry. They are expected to grow at the same rate as before. Their composition is unlikely to change. Their customer base is unique and unlikely to see any rapid change. INDUSTRY REVENUE GROWTH

YEAR

REVENUE

GROWTH

YEAR

REVENUE

GROWTH

2010

27,246

2015

31,123

2.9%

2011

28,128

3.2%

2016

32,457

4.3%

2012

29,011

3.1%

2017

35,126

4.4%

2013

29,805

2.7%

2018

36,375

3.6%

2014

30,235

1.4%

2019

36,875

3.6%

CAGR

2.1%

CAGR

3.45%

CSS has taken advantage of the rising economic tide over the past few years. As one of the most basic and staple industries within the broader food and beverage industry, CSS has been able to adjust to changing consumer needs. The focus in the last ive years have been towards easy to obtain and low to mid cost food items. The industry is in a perfect stage to leverage its position into much more higher quality and margin products. The US economy's continued recovery over the next ive years will play a large role in boosting demand for coffee and other snacks. Consumer spending is expected to increase over the ive years to 2019. As consumer spending continues to rebound, consumers will increasingly spend on CSS. Industry revenue is projected to rise at an average annual rate of 3.8% to $36.4 billion during the next ive years. INDUSTRY RISK

RISK COMPONENT

WEIGHT

SCORE

STRUCTURAL RISK

25%

5.16

GROWTH RISK

25%

4.20

SENSITIVITY RISK

50%

4.05

OVERALL RISK

3.86

1. Structure Risk ‐ Structural Risk is concerned with fundamental factors related to all industries. Structural risk is macro economic and depends on the US economy. The largest structural risk is the competition faced by the industry. Business‐ es are competing iercely for market share that may decrease revenues and operating and gross margins. However, larg‐ est irms can bene it from low to moderate barriers to entry that can help them to diversify and maintain or increase margins.

STARBUCKS VALUATION (SPRING 2015) 5

STRUCTURE COMPONENT

WEIGHT

SCORE

BARRIERS TO ENTRY

13%

8.00

COMPETITION

20%

9.00

EXPORTS

1.00

IMPORTS

2.00

ASSISTANCE

13%

7.00

LIFE CYCLE STAGE

20%

5.00

REVENUE VOLATILITY

20%

1.00

OVERALL STRUCTURAL RISK SCORE

5.16

2. Growth Risk ‐ Growth Risk is concerned with the relative performance of the industry over the next 5 years compared to the last 5 years. Growth Risk is expected to be medium to low over the outlook period. GROWTHCOMPONENT

WEIGHT

SCORE

2010‐2014 GROWTH RATE

25%

4.84

2015‐2019 GROWTH RATE

75%

4.00

OVERALL GROWTH RISK SCORE

4.20

3. Sensitivity Risk ‐ Sensitivity Risk is concerned with risk pertaining to the key external factors affecting the industry per‐ formance. The major factors affecting sensitivity are the consumer spending , consumer con idence index, per capita coffee consumption, and healthy eating index. Consumer spending, consumer con idence, and per capita coffee consumption are expected to increase while healthy eating index is expected to remain constant in the coming years. Hence, sensitivity risk is expected to be extremely low in the coming years.

SENSITIVITY COMPONENT

WEIGHT

SCORE

CONSUMER SPENDING

35%

2.86

HEALTHY EATING INDEX

25%

6.29

CONSUMER CONFIDENCE INDEX

20%

1.99

PER CAPITA COFFEE CONSUMPTION

20%

1.56

OVERALL SENSITIVITY RISK SCORE

3.28

KEY EXTERNAL DRIVERS 1. Consumer Spending ‐ Consumer spending has been steady and increasing over the last few years. However, due to ad‐ ditional jobs, increase in discretionary income, and easier access credit consumer spending is expected to increase over the next few years. US CONSUMER SPENDING

US NON‐FARM PAYROLLS

STARBUCKS VALUATION (SPRING 2015) 6

Consumer spending is expected to increase by 2.7% annually and Unemployment is expected to be between 5 to 5.5%

2. Healthy Eating Index ‐ The healthy eating index has steadily increased over the last few years. In the coming years, the healthy eating index is expected to continue growing. More people will prefer to eat healthier foods than before. Growth in the index is expected to be around 2.6% annually. US HEALTHY EATING INDEX

3. Consumer Con idence Index ‐ Consumer con idence is expected to recover and grow in stride with the economy. How‐ ever, the recover is slow as compared to the last ive years. We can expect consumer con idence to grow by 2.5% annually. CONSUMER CONFIDENCE INDEX

4. Coffee Consumption ‐ Per Capita Coffee consumption is expected to be stable over the coming years. Coffee consumption is expected to increase by 0.4% over the coming years. Coffee Consumption is in the saturated and in the mature phase of its life cycle. COFFEE CONSUMPTION

4. Coffee Prices ‐ Firms produce coffee by purchasing coffee beans and processing them into roast, ground coffee products, and ine liquid coffee’s. A drought bene its coffee prices because a drought decreases supplies. Rains hurt the coffee prices because rains increase supplies. Brazil is the largest exporter of coffee in the world. Brazil, sets the coffee prices and the weather in Brazil usually impacts the coffee prices. In 2014, Brazil had a severe drought due to which Coffee prices double compared to 2013 levels. Due, to exces‐ sive rains in the latter half of 2014 and 2015 Brazil Coffee prices are estimated to decrease this year. Coffee Prices are dif icult to predict and are largely volatile. A buyer can never predict the appropriate time to make effective purchasing decisions. Hence, due to the higher unpredictability of Coffee prices, irms which use effective hedging strategies and have multiple sourcing options are in a better position to overcome luctuations than irms which don’t do so. Moreover, Coffee consumption is almost completely oblivious of higher prices. Hence, in many cases higher prices of coffee can be passed on to consumers.

STARBUCKS VALUATION (SPRING 2015) 7

WORLD COFFEE PRICE ESTIMATES [BLOOMBERG] CURRENT

Q2 2015

Q3 2015

Q4 2015

2016

2017

2018

135.05

138.48

142.83

147.71

145.20

153.35

158.01

2.54%

3.14%

3.42%

‐1.7%

5.61%

3.04%

CAGR

2.04% PORTERS FIVE FORCES

1. Threat of Competition ‐ HIGH‐ Fierce competition is expected between the major chains and independent establishments over the next few years. This competition will increase as the market becomes saturated and irms attempt to appeal to a wider audience. The continued expansion of larger irms are likely to present strong challenges to its competitors. Firms will continue to tar‐ get various segments of the market. Firm will aggressively produce products which can be suited for various segments of the market. White‐collar workers, especially those in high‐income, urban locations, are the most likely to gravitate to independent coffee shops serving more expensive specialty coffee. These high‐income urbanites will be the major driver of the third‐wave trend that has taken the global coffee industry by storm over the past ive years.

2. Threat of New Entrants ‐ MODERATE– The industry is currently dominated by large and global players. The economies of scale of these players makes it dif icult for new entrants. The experience in understanding customer tastes and prefer‐ ences, managing supply chain and operations, and pricing decisions are problems new entrants need to overcome. Moreover, New entrants need to compete on quality, service, price and brand equity with existing members. To establish con idence with customer new entrants will take anywhere between 7‐10 years to achieve break even on their capital invest‐ ment. A common trend in which new entrants have been competing has been known as the third wave of coffee. The irst wave was simple coffee and the second wave was premium coffee such as Starbucks and the third wave includes specialty and reserve coffee’s. This segment has been among the fastest growing segments of the industry over the past few years. It includes cof‐ fee shops targeting coffee connoisseurs with high‐quality espresso, as well as siphoned and iltered coffee beverages. However, new entrants can compete with large players by targeting target speci ic niche segments of the market. BARRIERS TO ENTRY CHECKLIST

LEVEL

COMPETITION

HIGH

CONCENTRATION

MEDIUM

LIFE CYCLE STAGE

MATURE

CAPITAL INTENSITY

MEDIUM

TECHNOLOGY CHANGE

MEDIUM

REGULATION & POLICY

MEDIUM

INDUSTRY ASSIATANCE

NON

STARBUCKS VALUATION (SPRING 2015) 8

3. Threat of Substitutes ‐ MODERATE– The products are generic and easy to produce. Hence the threat of substitutes is very high in this industry. Consumers have become increasingly health conscious and, consequently, CSS have been changing their menus. Firms now have to forgo these health centric consumers or adapt their menus to cater to these markets. Due to the changes, irms have to invest in additional equipment, training, and inventory. New irms serving only these par‐ ticular interests of consumers such as Frozen Yogurt and Juices are in competition and are cannibalizing customers from larger irms. Larger irms are focusing on inorganic growth in the form of expansions to overcome the competition from alternates and substitutes.

4. Threat of Suppliers ‐ MODERATE– As demand increases the power of the supplier reduces. Larger irms in the industry almost own their supply chains end to end in their primary markets. The problem arises when it comes to secondary mar‐ kets such as emerging economies in which irms don’t have a strong presence and have to depend on domestic or local de‐ mand to ful il sourcing needs. Hence, as irms expand into newer markets the threat of suppliers increase. Firms source items such as basic foods, coffee beans, and dairy items. Firms, historically have not and looking forward will not face substantial threats from their suppliers. Moreover, the inputs for the industry are standard and can be obtained from multiple suppliers.

5. Threat of Buyers ‐ LOW– As an industry the buyers have little to no power. As coffee and snacks have become staples in a person’s diet the power of the irms have increased and the buyers have decreased. To a large extent buyers have negligible buying power even when prices are increased. Industry pricing is competitive and switching costs are negligible; hence, buyers have no advantage in switching products. Moreover, the number of buyers are varied and cant be segmented by race, gender, demography, or tastes. Hence, the indus‐ try consists of same set of generic products sold to the same set of customers. COMPETITIVE LANDSCAPE 1. Starbucks ‐ The world's #1 specialty coffee retailer, Starbucks has more than 21,000 coffee shops in about 65 countries. The outlets offer coffee drinks and food items, as well as roasted beans, coffee accessories, and teas. Starbucks operates shops through franchising and licensing mediums. The franchising mediums are primarily Internation‐ al while the irms own shops are US centered.

STARBUCKS VALUATION (SPRING 2015) 9

2. McDonalds ‐ McDonald's has more than 35,000 restaurants serving burgers and fries in about 120 countries. Most of the outlets are free‐standing units offering dine‐in and drive‐through service, but McDonald's also has many eateries located in airports, retail areas, and other high‐traf ic locations. About 80% of the restaurants are run by fran‐ chisees or af iliates.

3. YUM! ‐ YUM! Brands is the largest fast‐food operator in the world in terms of num‐ ber of locations, with more than 40,000 outlets in about 125 countries. Franchisees, af iliates, and licensed operators run about 75% of the company's restaurants.

4. Dunkin ‐ Dunkin is a leading multi‐concept quick‐service restaurant franchisor that operates both the Dunkin' Donuts and Baskin‐Robbins chains. It has more than 18,000 franchise locations operating in about 60 countries. With nearly 11,000 units in about 30 countries , Dunkin' Donuts is the world's leading doughnut chain. Baskin‐Robbins is a top ice cream and frozen snacks outlet with more than 7,300 locations in 45 countries.

PERFORMANCE vs SPX [5 YEARS]

STARBUCKS VALUATION (SPRING 2015) 10

FIRM OVERVIEW AND STRATEGY HISTORY Starbucks began in 1971. Back then it was a roaster and retailer of whole bean and ground coffee, tea and spices with a single store in Seattle’s Pike Place Market. Today, Starbucks serves millions of customers every day with exceptional products and more than 21,000 retail stores in about 65 countries. Starbucks stores are a neighborhood gathering place for meeting friends and family. Starbucks customers enjoy quality service, an inviting atmosphere and an exceptional beverage. PRODUCTS & BRANDS Starbucks Products include a range of exceptional products that customers enjoy in its stores, at home, and on the go. Coffee: More than 30 blends and single‐origin premium coffees Handcrafted Beverages: Fresh‐brewed coffee, hot and iced espresso beverages, Frappuccino® coffee and noncoffee blended beverages Starbucks Refreshers: Smoothies and Teas Merchandise: Coffee‐ and tea‐brewing equipment, Verismo System™ by Starbucks®, mugs and accessories, packaged goods, music, books and gifts Fresh Food: Baked pastries, sandwiches, salads, salad and grain bowls, oatmeal, yogurt parfaits and fruit cups. Consumer Products Coffee and Tea: Whole bean and ground coffee (Starbucks and Seattle’s Best Coffee brands), Starbucks VIA® Ready Brew, Starbucks® K‐Cup® portion packs, Starbucks® and Teavanna® Verismo™ pods, Tazo® tea ilterbags, and tea latte concentrates. Ready‐to‐Drink (RTD): Starbucks® bottled Frappuccino® coffee drinks, Starbucks Discoveries® chilled cup cof‐ fees, Starbucks Discoveries® Iced Café Favorites™, Starbucks Iced Coffee, Starbucks Doubleshot® espresso drinks, Star‐ bucks Doubleshot® Energy+Coffee drinks Starbucks Refreshers Beverages: Evolution Fresh bottled juices, Tazo® bottled iced and juiced teas.

STARBUCKS

TAZO

SEATTLE’S BEST COFFEE

EVOLUTION FRESH

TEVANA

LA BOULANGE

BUSINESS SEGMENTS—GEOGRAPHICS 1. Americas ‐ The Americas segment has been the largest segment by revenue for Starbucks. Americas segment is our most mature business and has achieved signi icant scale. The Segment contributes to 72.8% of Starbucks sales. The seg‐ ment has seen strong growth in the last few years which is expected to continue over the coming years. The segment has seen 6% increase in same store sales. The number is expected to be in the middle digits over the coming years. Ticket sizes have been the in $3 which have been the highest compared to all other regions. 2. China and Asia Paci ic ‐ The CAP region has been growing since 2010. It currently is the third largest segment by rev‐ enue for Starbucks. In the years to come the segment is expected to bypass EMEA and become the second largest market for Starbucks. The CAP segment is expected to bring strong top‐line growth with the highest margins compared to all other segments. The segment currently contributes to 6.9% of the overall sales. Same store sales have been the highest in the CAP segment growing at 7%.

STARBUCKS VALUATION (SPRING 2015) 11

3. Europe, Middle East & Africa ‐ The EMEA region is the second largest segment by revenues for Starbucks. The segment contributes 7.9% to overall Starbuck revenues. Revenues have been increasing but the overall revenue contribution has been decreasing for the EMEA segment. The segment has had lack‐luster performance in the last few years. This has been due to the slowing growth in the Eurozone which has caused rapid decline in jobs and wages. The EMEA segment is expected to improve in a few years as the global economy improves. Additionally, a broader product mix will help in increasing reve‐ nues in the EMEA segment. Same store sales have grown at 5% in the EMEA segment. Average ticket sizes have been $2 in the EMEA segment. 4. Other ‐ The Other segment includes revenues from Teavana and Seattle’s Best Coffee stores. The segment accounted for 3% of Starbucks revenues. 5. Channel Development ‐ The segment includes consumer packaged goods, foodservice and licensing. The segment has been consistently growing in the last few years. It contributes 7.2% by revenue for Starbucks.

BUSINESS SEGMENTS ‐ OPERATIONS

1. Company Operated Stores ‐ Company operated stores are signature Starbucks stores which are owned and operated by the company. These formats are popular in the Americas region. Company operated retail stores command higher revenues but lower margins as compared to Licensed stores. Company operated stores contribute 78.9% of overall Starbucks reve‐ nues. 2. Licensing Stores ‐ These stores are popular in regions in new and emerging economies. These formats are gaining more popularity even in the Americas where Starbucks intend to operate Drive‐Through and Micro Store formats. Starbucks, brands such as Tevana, and Seattle’s Best Coffee operate primarily on the licensing model. As a irm Starbucks prefers the Company Operated Stores model to maintain quality of service its adheres too. GROWTH DRIVERS

1. New Store Estimates‐ New Stores are expected to increase in the coming years, both in the licensed and company operat‐ ed formats. COMPANY OPERATED STORES (COS) SEGMENTS AMERICAS

2011

2012

7,623.00 7,857.00

2013

2014

2015

2016

2017

8,078.00

8,395.00

8,720

9,092

9,480

% of Growth

EMEA

872.00

882.00

853.00

817.00

817

% of Growth

‐3%

‐4%

CAP

512.00

666.00

906.00

1,132.00

1,415

2,829

4009

% of Growth

30%

36%

25%

100%

17%

OTHER

0.00

357.00

369.00

389

410

432

% of Growth

TOTAL

9,007

9,405

10,194

10,713

11,341

13,148

14,738

STARBUCKS VALUATION (SPRING 2015) 12

By 2017 the number of COS all over the world are expected to be 14,000. The number of stores in the Americas are expected to increase by an average of 4% to 9480 stores. The number of stores in the EMEA region are expected to be constant at the current level at 817. I have assumed the growth rate in the COS in the EMEA region to be 0%. The number of stores in the CAP region are expected to grow between 16 to 25%. The number of stores will get a sudden boost in 2016 due to acquisition of 1060 Japanese stores. LICENSED STORES (LS) SEGMENTS

2011

AMERICAS

2012

4,776.00 5,830.00

2013

2014

2015

2016

2017

5,415.00

5,796.00

6121

6368

6625

% of Growth

22%

‐7%

EMEA

886.00

987.00

1,116.00

1,323.00

1,473

1,684

1,926

% of Growth

11%

13%

19%

11%

14%

2,976.00

3,492.00

4,059

2,993

3,424

CAP

2,334.00 2,628.00

% of Growth

13%

17%

16%

‐26%

14%

OTHER

0.00

66.00

42.00

% of Growth

‐36%

TOTAL

7,996

9,445

9,573

10,653

11,695

11,087

12,016

By 2017 the number of LS all over the world are expected to be 13,904. The number of stores in the Americas are expected to increase by an average of 4.67% to 6625 stores. The number of stores in the EMEA region are expected to increase at 13% to 1926. The number of stores in the CAP region are expected to grow to 5311 stores. The number of stores will decrease in 2016 be‐ cause 1060 licensed stores will be converted to company owned stores.

NEW STORES BY REGION ‐ COMPANY OPERATED STORES NET STORE ADDITIONS AMERICAS EMEA CAP OTHER

2015

2016

2017

628 2397 852 325 372 388 0 0 0 283 2004 442 20 21 22 NEW STORES BY REGION ‐LEASED STORES

AVERAGES 4% 0% 25% 5%

2015

2016

2017

AVERAGES

NET STORE ADDITIONS AMERICAS EMEA CAP OTHER

1042 325 150 567 0

‐608 247 211 ‐1066 0

1014 257 242 516 0

4% 14% 14% 0%

STARBUCKS VALUATION (SPRING 2015) 13

TOTAL STORE ESTIMATES

2011

2012

2013

2014

2015

2016

2017

TOTAL STORES

17003

18850

19767

21366

23036

24825

26754

% of Growth

11%

The total stores are estimates to grow by 8% annually till 2107. In 2017 the overall number of stores will be 26692. 2. Growth in Store Sales

% GROWTH IN STORE SALES ‐ COMPARABLE STORE SALES ‐ COS 2015 2016

NET STORE ADDITIONS AMERICAS BASE WORSE BEST EMEA BASE WORSE BEST CAP BASE WORSE BEST OTHER BASE WORSE BEST

4% 4% 3% 5% 3% 3% 2% 4% 2% 2% 1% 3% 25% 25% 15% 50%

5% 5.00% 4% 6% 4% 4.00% 3% 5% 3% 3% 2% 4% 25% 25% 15% 50%

2017 6% 6% 5% 7% 3% 3% 2% 4% 4% 4% 3% 5% 25% 25% 15% 50%

In the Americas, EMEA, & CAP region Comparable Store Sales are expected to grow at an average of 5%, 3.33% and ~2.67% The increase in sales will be driven by increase in product mix. Product offerings such as breakfast foods, lunch items, juices and pastries will be instrumental in increasing ticket sizes. As ticket sizes increase and customers remain constant the store sales will increase In the CAP region increase in brand awareness and market penetration will help in increasing sales

STARBUCKS VALUATION (SPRING 2015) 14

% GROWTH IN STORE SALES ‐ LS 2015 2016

NET STORE ADDITIONS AMERICAS BASE WORSE BEST EMEA BASE WORSE BEST CAP BASE WORSE BEST OTHER BASE WORSE BEST

2017

10%

11%

10%

12%

10%

12%

11%

13%

0% 0%

In the Americas, EMEA, & CAP region LS store sales are expect to increase on average at 9%, 11.33%, and 4%. In Americas the increase in sales will be obtained from different store formats such as of ice building stores, drive through stores, airport stores, and micro stores. In the EMEA region the increase will be in luenced by various product offerings. The licensing revenue includes a commis‐ sion from the sale as well as licensing fees. Moreover, the food supplied to the licensing partners will be Starbucks food and not from third parties. Hence, Starbucks stand to gain increased revenues through cross functional mediums and increase in the number of stores. In the CAP region Starbucks revenue from license stores will be driven by increase in the number of stores and licensing fees. 3. Ticket Sizes Ticket Sizes dropped in 2014 but are expected to increase continuing further. Starbucks has taken various steps to increase ticket sizes such as loyalty cards, mobile order and pay, and alternate drink and food options. Starbucks estimates ticket sizes to be around $5 by 2016

HISTORICAL TICKET SIZES 2011

2012

2013

2014

$2.0

$1.0

$2.0

$3.0

STARBUCKS VALUATION (SPRING 2015) 15

4. Coffee & Tea Leadership ‐ Starbucks wants to strengthen and visualize its position in coffee leadership. Moreover, with the current acquisition of Tea brands such as Tazo and Tevana, Starbucks wants to build a strong position in leadership. Star‐ bucks has shown continued customization to accustom itself to change in preferences for customer needs and adoption of technology to improve the experience customers face from the purchase to the delivery stages. 5. Diversi ication ‐ Starbucks is diversifying tis image from a breakfast brand to a lunch and dinner brand. The irm is im‐ proving its product mix to include a larger variety of foods, and beverages to serve its customers. 6. Japanese Acquisition ‐ The Japanese acquisition has assisted Starbucks to solidify its position in the CAP region. The acquisition is an example the growth Starbucks prefer to establish with its partners. The irm enters new markets with domestic partners to assist in operation and supply chain activities. When Starbucks feels that it has the appropriate exper‐ tise and skillset to run a full blown operation Starbucks will acquire licensed store into the Company Owned Stores portfolio. The Japanese acquisition will provide Starbucks with 1650 licensed stores that will cost the company $893 million and pro‐ vide the irm with $987 million in additional revenue. The additional revenue will contribute to an increase of about 6 to 8% in top line revenue which will bring 2015 revenue estimates to increase by 16 to 18% y.o.y levels. Starbucks is expected to fund the acquisition in a two phase process. The irst phase was completed in the irst quarter of 2015. The next phase is expected some time in the remaining quarters of 2015. The irm expects strong EPS growth in iscal 2015, due in part to an anticipated acquisition‐related gain of approximately $325 million to $375 million after‐tax, or $0.43 to $0.49 per share. The irm has already liquidated its foreign investments ‐ In Japanese Yen to fund its expansion. Japan will become the single largest market for Starbucks after the United States. 7. Loyalty Cards ‐ The Starbucks Card and our other branded stored value card programs are designed to provide customers with a convenient payment method, support gifting, and increase the frequency of store visits by cardholders, in part through the related My Starbucks Rewards loyalty program. Stored value cards are issued to customers when they ini‐ tially load them with an account balance. They can be obtained in our company‐operated and most licensed stores in North America, China, Brazil, and many of our markets in the EMEA segment, as well as on‐line, via the Starbucks mobile app, and through other retailers, including a number of other international locations. Starbucks records income from the cards when these cards are redeemed. Starbucks earned brokerage revenue from the cards worth $38.3 million in 2014, $33 million in 2013, and $65.8 million in 2012. 8. Mobile Order and Pay ‐ Mobile Order & Pay allows customers to place orders in advance of their visit and pick them up at their chosen Starbucks store. The mobile ordering experience is seamlessly integrated into Starbucks world‐class mobile app and My Starbucks Rewards loyalty program. Mobile Order & Pay is available for customers using a Starbucks app for iPhone. Starbucks is able to increase and anticipate demand that will help the company increase foot‐traf ic and directly impact vol‐ umes. Starbucks is keenly focused on adoption of seamless technology to increase COS and LS sales. 9. Employer of Choice and Entrepreneurial Future ‐ Starbucks is focused on providing its employees services to de‐ crease attrition. There have been various strategies adopted by Starbucks. The irm maintains several equity incentive plans under which they grant stock options or stock appreciation rights to em‐ ployees. Starbucks employed approximately 191,000 people worldwide as of September 28, 2014. Starbucks has been providing education opportunities to its employees through online distance learning programs from Ari‐ zona State University. Moreover, the irm wants to decrease store manager rotation. The irm aims to focus on entrepreneurial stores in which the store manager is responsible for increasing sales and improving ef iciency in the store. Hence, in the forthcoming years the store become as unit as a driver of sale than the customer.

STARBUCKS VALUATION (SPRING 2015) 16

10. Tax Advantages ‐ Due to the Tax advantage the firms tax rate or 2015 is expected to be 31% , a 3% drop from its last tax rate of 34%. INVESTMENT RECOMMENDATION Investment Recommendation: Starbucks has a lower co‐relation with the XLY and S&P 500 compared to other stocks in our portfolio. The irm is moving from it’s a strong income stock to a growth stock which supports capital preservation. More‐ over, the irm sees strong sales growth supported by increase in COS and LS sales growth, and ticket sizes. The irm is in line with international expansion in which it can obtain the bottom line margins which will help offset the irms capital expenditures. The irm has been positioning its brand to offer a larger variety of products to become a lunch and dinner place along with its breakfast place image. The irm is in perfect line of Market Consolidation. Starbucks, is in a stronger position compared to its peers when compared to debt to equity, current and liquidity ratios which help the irm to be more stable than its peers. The irms primarily owns its operations ‐ or ‐ in line with owning all its operations which will assist the irm in maintain a strong top line growth, quality, and ef iciency. Moreover, the irm can effectively manage its employees and implement change. Consumer Discretionary Spending is expected to rise which will directly bene it the Consumer Discretionary sector, in other words bene it irms such as Starbucks. In lieu and support of the growth drivers I recommend Starbucks to be a strong Hold for the short and long term. Lastly, my free cash low and dividend models support Starbucks as a strong Hold. Hence, I irmly believe that the EiF com‐ munity should Hold Starbucks.

CONSENSUS [ANALYSTS] BUYS

79.3%

HOLDS

20.7%

SELLS

0.0%

VARUN GADIA

HOLD

INVESTMENT RISKS 1. Economic Conditions ‐ As a retailer that is dependent upon consumer discretionary spending, the irms global re‐ sults of operations are sensitive to changes in macro‐economic conditions. The irms customers may have less money for dis‐ cretionary purchases and may stop or reduce their purchases of our products or trade down to Starbucks or competitors' lower priced products as a result of job losses, foreclosures, bankruptcies, increased fuel and energy costs, higher interest rates, higher taxes and reduced access to credit. 2. Brand Value ‐ Business incidents, whether isolated or recurring and whether originating from the irm or its business partners, that erode consumer trust, such as actual or perceived breaches of privacy, contaminated food, recalls or other po‐ tential incidents discussed in this risk factors section, particularly if the incidents receive considerable publicity, including rapidly through social or digital media, or result in litigation, can signi icantly reduce brand value.

STARBUCKS VALUATION (SPRING 2015) 17

3. Firm Strategy ‐ There is no assurance that the irm will be able to implement important strategic initiatives in ac‐ cordance with its expectations, which may result in an adverse impact on its business and inancial results. These strategic initiatives are designed to create growth, improve the irms results of operations and drive long‐term shareholder value, and include: 1. Successfully leveraging Starbucks brand portfolio outside the company‐operated store base, including its in‐ creased focus on international licensed stores; 2. Focusing on relevant product innovation and pro itable new growth platforms, including retail tea, and achiev‐ ing customer acceptance of these new products and platforms while maintaining demand for our current offer‐ ings; 3. Continuing the growth of its Channel Development business; 4. Balancing disciplined global store growth and existing store renovation while meeting target store‐level unit economics in a given market 5. Executing a multi‐channel advertising and marketing campaign to effectively communicate its message directly to Starbucks consumers and employees 6. Strategic acquisitions, and joint ventures. 4. Competition ‐ The specialty coffee market is intensely competitive, including with respect to product quality, innovation, service, convenience, and price. Starbucks faces signi icant and increasing competition in all these areas in each of its chan‐ nels and markets. Moreover, Starbucks does not have leadership positions in all channels and markets. Increased competition in the US packaged coffee and tea and single‐serve and ready‐to‐drink coffee beverage markets, in‐ cluding from new and large entrants to this market, could adversely affect the pro itability of the Channel Development seg‐ ment. 5. Americas Dependency ‐ Starbucks’s inancial performance is highly dependent on its Americas operating segment, as it comprised approximately 73% of consolidated total net revenues in iscal 2014. If the Americas operating segment revenue trends slow or decline Starbuck’s other segments may be unable to make up any signi icant shortfall and its business and i‐ nancial results could be adversely affected. 6. International Operations Risks ‐ Starbucks future growth increasingly depends on the growth and sustained pro itabil‐ ity of our CAP and EMEA operating segments. Some or all of its international units, may not be successful in their operations or in achieving expected growth. The performance of these international operations may be adversely affected by economic downturns in one or more of the countries in which the irm operates. In particular, China contributes meaningfully to both net revenues and earnings for the CAP segment and our Japan contributes signi icantly to earnings in that segment. In the EMEA segment, UK accounts for a signi icant portion of the net revenues. A decline in performance of any of these countries could have a material adverse impact on the results of the irms international operations. 7. Operating Margins ‐ Due to rapid expansion the irms operating margins are expected to decrease. It is essential for the irm to understand the ways through which it intends to increase its operating margins. Increase in revenues without de‐ crease in operating expenses may not be a long term viable strategy for the irm. Various factors such as regulation, supply chain, and SG&A can impact the irms margins in international markets. 8. Supply Chain Dynamics ‐ The irm is forming strong partnership across the supply chain with various vendors in interna‐ tional markets. Although the vendors are rigorously checked by Starbucks the integrity, ef iciency, and inancial health of the vendors play an important role in timely and quality delivery of Starbucks products to its customers.

STARBUCKS VALUATION (SPRING 2015) 18

PRO FORMA ACCOUNTING Pro‐Forma accounting includes various estimates ranging from revenue, gross operating margins, net operating margins, Price to Earnings, Debt Schedule, Cost of Equity, Other Income, Working Capital, Dividend, Stock Issuance, and Stock Repur‐ chases. The estimates have been obtained either from management or from Bloomberg. Some of the estimates have been as‐ sumed by me ‐ Almost all my assumptions, that are not from Bloomberg or Management, have been performed on historical estimates. In my pro forma accounting I only provide explanation for my base case assumptions. However, I provide 3 different values for cost of equity. REVENUE ESTIMATES Management has estimates that stores will be the revenue unit and revenue driver in the years to come. Moreover, I feel irm performance will be judged by the ways the stores have performed rather than by the number of customers or the purchases by the customer. As the customer base grows customer segmentation and customer growth drivers are not appropriate num‐ bers to calculate increase in revenue. Hence, I have calculated revenue based on the revenue increases per store rather than the number of customers. In my revenue calculation I calculated the number of stores present in each region in 2015,2016 and 2017. In 2015 manage‐ ment estimates addition of 1650‐1700 new stores. I have broken management guidance for new store openings and closing in all regions for 2015. I grow this number by historical estimates in 2016 and 2017. In 2016, the Japanese acquisition which will be completed will add 1060 new stores. These 1060 will be new Company Operated Stores which will be obtained from licensed stores. Overall, I obtained new stores growing at 8% from 2015 to 2017 which is in line with 2014 ‐ The Year the Management de‐ cided to invest in Internationally and domestically new stores. I further calculate the growth in the revenue per store per region. These estimates were in line with management guidance for the Americas and EMEA. For the CAP region these numbers were estimated. Further, I multiple the sales per store per region to obtain the overall sales estimates for the stores. For Channel Development, I used historical numbers for Consumer Packaged goods. However, as the number of stores in‐ crease specialty operations increase. Hence, I used an increase in growth for Specialty operations division. For the Food Service division I assumed a higher growth rate for all divisions. I assumed that Starbucks will launch food ser‐ vice in the CAP region from 2016 ‐ Especially after Japan becomes its second largest market. Lastly, I added 6% increase in sales due to acquisition of Starbucks Japan for 2015. The 6% contributes to $987 million. Overall, Total Revenues are growing at CAGR 9.29% from 2013 to 2015. For 2015, the revenues will grow by 16%, the spike in revenue is due to the 6% increase in sales due to acquisition of Starbucks Japan. For 2016, the revenues will grow at 10% due to increase in operating margins. For 2017, the increase in revenue will be driven by increase in operating margins, larg‐ er product offerings to driver higher ticket sizes and increase in the number of stores. US $ [Millions]

FY 2011

FY 2012

FY 2013

FY 2014

FY 2015

FY 2016

FY 2017

Revenue % Growth

11,700.4 9.27%

13,299.5 13.67%

14,892.2 11.98%

16,447.8 10.45%

19,090.5 16.07%

21,004.9 10%

23,606.9 12%

STARBUCKS VALUATION (SPRING 2015) 19

SEGMENTS AMERICAS % of Growth EMEA % of Growth CAP % of Growth OTHER % of Growth TOTAL

REVENUE BY SEGMENTS ‐ COMPANY OPERATED STORES 2011 2012 2013 2014 2015 11739 8,366 9,077 10,038 10,867 NA 9% 11% 8% 1044 905.50 968.30 932.80 1,013.80 NA 7% ‐4% 9% 1096 552.30 721.40 917.00 859.40 NA 31% 27% ‐6% 314 0.00 0.00 150.40 238.20 NA NA NA 58% 9,823 10,767 12,039 12,978 14,193

SEGMENTS AMERICAS % of Growth EMEA % of Growth CAP % of Growth OTHER % of Growth TOTAL

SEGMENTS CPG % of Growth SPECIALTY OPERATIONS % of Growth TOTAL

REVENUE BY SEGMENTS ‐ LICENSED STORES 2011 2012 2013 2014 2015 1222 677 826 915 1,075 NA 22% 11% 17% 292 112.20 139.50 190.30 238.40 NA 24% 36% 25% 323 190.90 232.20 245.30 270.20 NA 22% 6% 10% 5 27.70 12.80 9.50 5.10 NA ‐54% ‐26% ‐46% 1,008 1,210 1,361 1,589 1843

2011

FOOD SERVICE DIVISION 2012 2013 2014

2016 12852

2017 14204

1086

1119

2257

2714

413

544

16,607

18,581

2016 1382

2017 1577

374

479

297

357

2058

2417

2015

2016

2017

46%

42%

‐17%

29.10

33.50

36.90

42.60

15%

10%

15%

0.00

148.10

195.80

233.80

253.60

279

312

356

NA 200

32% 263

19% 318

8% 335

370

464

525

CHANNEL DEVELOPMENT 2012 2013 2014

2015

2016

2017

1,320

1,479

1,671

2011 553.2

952.1

1,056.0

1,178.8

72%

11%

12%

0.0

364.7

367.2

378.22

397.13

NA 553

NA 952

NA 1421

1% 1546

1698

1876

413.01 2084

STARBUCKS VALUATION (SPRING 2015) 20

SEGMENTS AMERICAS % of Growth EMEA % of Growth CAP % of Growth OTHER % of Growth

REVENUE PER STORE– COMPANY OPERATES STORES 2011 2012 2013 2014 2015

2016

2017

1.35

1.41

1.50

1.28

1.33

1.37

0.77

0.80

0.83

0.81

1.01

1.26

REVENUE PER STORE– LICENSED 2011 2012 2013 2014

2015

2016

2017

0.14

0.17

0.19

0.20

0.22

0.24

19%

10%

0.13

0.14

0.17

0.18

0.20

0.22

0.25

12%

21%

0.08

0.09

0.08

0.09

‐7%

‐6%

0.00

0.14

0.12

140%

‐16%

1.10

1.16

1.24

1.29

1.04

1.10

1.09

1.24

13%

1.08

1.01

0.76

‐7%

‐25%

0.00

0.42

0.65

420%

53%

STARBUCKS VALUATION (SPRING 2015) 21

OTHER ESTIMATES 1. Operating Margin (OM) Estimates ‐ Management Estimates Operating Margin to slightly drop for 2015. I have decreased OM by 1% for 2015 to 17.6%. Management estimates OM to reach back to the same levels for 2016 and increase for 2017. The 2017 increase is due to increase in earnings from high OM regions such as CAP. For 2016 my OM estimates are 18.6% and 19.6%. I have not broken or split down my operating expenses due to the complexities in various segments and regions. Moreover, the Japanese expansion alters the OM due to which historical estimates are not appropriate. 2. Interest Expense: I calculate Interest Expense for the irm based on the Debt Schedule. The interest rate for Star‐ bucks luctuates on the basis of the underlying rate.

2016 Notes 2017 Notes

2018 Notes 2023 Notes

DEBT SCHEDULE VALUE RATE 400 0.88% 625 6.25% 353 786

2% 3.85%

A -9 -17

B 9 17

-14 -58

14 58

A -> 100 BPS Increase in Underlying T-Bills B -> 100 BPS Decrease in Underlying T-Bills

I have assumed interest rates to increase by .25% in 2016 and .5% in 2017. 3. Depreciation and Amortization: I have used historical average for D&A. I have assumed D&A activity in 2016 and 2017 to increase due to increased capital expenditure. 4. Stock Issuance and Repurchases: Management has stated that it has 16 million stocks left to repurchase in its stock repurchase program. I have assumed 8 million repurchase in 2015 and 2016. I have assumed no repurchase in 2017. Moreover, I have assumed 2 million stocks ‐ historical ‐ to be issued each year. 5. Income Tax Expense: Management estimates 3% tax bene it due to the Japanese acquisition. Hence, I have as‐ sumed 31% income tax rate in 2015. In 2016 and 2017, I have assumed historical tax rate of 34%. 6. Number of Diluted Shares: I assumed a constant difference between weighted and diluted shares of 20 million shares for 2015, 2016 and 2017.

STARBUCKS VALUATION (SPRING 2015) 22

VALUATION ASSUMPTIONS 1. Dividend: I have estimated an increase in dividend by 20% in 2015, 15% in 2016 and 20% in 2017. In 2015 man‐ agement has shown the increase in dividends by the dividend paid in the irst quarter. Moreover, additional cash to the irm due to the acquisition will help management pay higher dividends. Due to the slowing growth in 2016 compared to the growth rate in 2015 I estimate dividend to grow at a slower rate. Lastly, in 2017 I have estimated dividends to grow by a higher rate compared to 2016 due to the bene its realized from 2015 and 2016 investments. My estimates are in line with Bloomberg estimates. 2. Risk Free Rate: I have used the current 30 year US Treasury Bond risk free rate which was 2.09% as of 3/05/2015. 3. Beta: I have used the average beta from various sources and my own regression.

Beta Estimates Bloomberg Yahoo Finance Google Finance Reuters Morning Star Research Value Line Varun Gadia Mean

0.74 0.88 0.77 0.78 0.89 1.00 1.02 0.87

4. Price to Earnings ‐ P/E: Starbucks has been trading at relatively high Price to Earnings. I have estimates the Price to Earn‐ ings to decrease by 1.5x in 2016 and 1x in 2016 to settle at 27.5. This is 1x times lesser than Starbucks’s historic Price to Earnings multiple. I strongly feel that underestimating the P/E number will provide a bias in our valuation. Hence, I used His‐ torical estimates. Historical P/E 2006 46.64 2007 30.11 2008 21.07 2009 24.31 2010 20.19 2011 24.37 2012 28.33 2013 35.03 2014 28.53 Current P/E 32 Average P/E 28.73 5. Market Premium: I feel market premium is not the best representation for the Cost of Equity. Hence, I have 2 dif‐ ferent estimates for the market premium. In my base case I use 8% as the Market Premium. I add various premiums such as In lation, Default, and Liquidity Premiums. I feel the In lation premium to be 1.3% based on my expected value for in lation rate. I feel there is almost 1% to negligible chance for Starbucks to default on its debt, and I feel the Starbucks stock is highly liquid hence 0% liquidity premium.

Premium Calculations Inflation Default Market Risk Liquidity Total

1.30% 1% 5.70% 0% 8.00%

STARBUCKS VALUATION (SPRING 2015) 23

VALUATION ASSUMPTIONS In my second case I use 5.7%, the annual premium of the stock market above the 30 year T‐bond yield since 1926.

Market Premium Base General

8.00% 8.00% 5.70%

5. Cost of Equity: I use both CAPM and Bond Buildup Method to Estimate the cost of equity. Through CAPM I obtain the cost of Equity as 9.04% and 7.04% . When using Bond Buildup Method the cost of debt is 3.13% for Starbucks. I add the Market Risk premium which is 5.7% which brings the Cost of Equity to 8.83%.

Cost of Equity CAPM Bond Build Up Method

7.04% 7.04% 8.83%

Bond Buildup Method Cost of Debt 3.13% Premium 5.70% Cost of Equity 8.83%

STARBUCKS VALUATION (SPRING 2015) 24

RESULTS FROM VARIOUS ASSUMPTIONS

Assumptions Risk Free Rate

2.09%

Premium

5.70%

Beta

0.87

Cost of Equity

7.04%

Estimated FY 2017 EPS

4.03

Estimated FY 2017 P/E

27.5x

Undervalued –DDM

5.24%

Undervalued – FCFE

13.75%

Assumptions Risk Free Rate

2.09%

Premium

8.00%

Beta

0.87

Cost of Equity

8.83%

Estimated FY 2017 EPS

4.03

Estimated FY 2017 P/E

27.5x

Undervalued ‐ DDM

.94%

Undervalued ‐ FCFE

9.19%

Assumptions Risk Free Rate

2.09%

Premium

8.00%

Beta

0.87

Cost of Equity

9.04%

Estimated FY 2017 EPS

4.03

Estimated FY 2017 P/E

27.5x

Undervalued ‐ DDM

.43%

Undervalued ‐ FCFE

8.65%

STARBUCKS VALUATION (SPRING 2015) 25

RATIO ANALYSIS

Pro itability Ratios Pro it margin Gross margin ROA ROE Liquidity Ratios Current Quick Debt Utilization Debt to Equity Leverage Asset Utilization Asset Turnover Valuation Ratios P/E Price/Book Price/Cash Flow EPS DuPont Analysis Pro it Margin Asset Turnover Leverage ROE

SBUX 12.57% 58.30% 18.57% 42.41%

1.37 0.81

0.39 2.28

1.48

28.52x 10.69 93.14 2.75

12.57% 1.48 2.28 42.41%

INDUSTRY 15.34% 61.26% 12.46% 44.37% 1.20 0.82 2.16 4.40 1.01 23.98X 12.57 36.26 2.91 15.34% 1.01 4.40 44.17%

MCD 17.34% 55.43% 13.42% 32.97%

1.17

YUM! 7.91% 45.30% 12.34% 56.61% 0.68 0.37 2.16

2.46

4.59

0.77

1.56

X 7.02 13.65 4.85

21.49x 20.52 15.85 2.37

17.34% 0.77 2.46 32.85%

7.91% 1.56 4.59 56.64%

1.52 1.20

DNKN 23.55% 86% 5.50% 45.49% 1.24 0.88 4.94 8.27 0.23 26.47x 12.05 22.4 1.67 23.55% 0.23 8.27 44.79%

STARBUCKS VALUATION (SPRING 2015) 26

1. Pro itability Ratios– Starbucks Pro it margin is comparatively lower as compared to its peers. Starbucks primarily operat‐ ed company operated stores due to which draws lower its pro it margin. Starbucks can improve its margins by increasing th e number of licensed stores. Starbucks identi ies the pro it margin as a problem and has been venturing regions with higher earnings than Americas. In regions in which margin pressures are the highest, Starbucks has increased licensing efforts such as the EMEA region. The cost of coffee also drivers the pro itability lower than its competitors who have less volatile inputs. Starbucks Gross margins are slightly lower than the industry because Starbucks used to source food items from third parties, coffee prices, and dairy prices. Starbucks aim to sell higher proportion of food items and provide a higher number of specialty services which can assist the company to increase its margins. Compared to irms which are of comparable size and sell generic products Starbucks margins are low but not worrisome. Due, to recent acquisitions, and lower coffee prices Starbucks Gross Margins are expected to increase. 2. Return on Assets ‐ Compared to its peers Starbucks has the best Return on Assets. The value shows the efforts taken by management to strategically place stores and focus on value adding and outsource non‐value adding activities. 3. Liquidity Ratios ‐ Compare to the Industry Starbucks has the strongest liquidity ratios. The recent acquisitions and Litiga‐ tions have lowered the liquidity ratios than before. Starbucks Liquidity ratios may not come to lower levels because the irms plans to increase or maintains its capital expendi‐ tures which will lower the cash available to the irm. 4. Debt Utilization ‐ Compare to the industry Starbucks has the one of lowest debt to equity. Due to the low debt the irm is stable and is poised for growth. Moreover, the irm can raise higher capital due to the lower debt to equity ratio. In the last few years Starbucks Debt to Equi‐ ty increased due to acquisitions. Starbucks has been using its strong Debt to Equity position to raise capital internationally which will assist the irm to over‐ come currency luctuations. 4. Asset Turnover‐ Starbucks has a higher Asset Turnover compared to the industry. The reason is because the irm oper‐ ates a larger proportion of company operated stores in its primary markets which help in increasing its Sales volumes. 5. Valuation ‐ Compared to its peers Starbucks has a higher valuation. The higher valuation represents a growth stock. Star‐ bucks is currently in an expansion phase due to which the higher valuations are justi ied. The valuations have increased sharply since the last time the stock was pitched due to strong Quarter 4 growth and even bet‐ ter 2015 projections. 6. Price to Cash Flow‐ Starbucks Price to Cash‐Flow increased substantially due to the payout in the Kraft litigation and the Japanese acquisition. The Price to Cash Flow is really worrisome but will decrease substantially and come to historic levels in the coming years.

STARBUCKS VALUATION (SPRING 2015) 27

DIVIDEND GROWTH MODEL

Company Information Ticker

SBUX

Recent Price

$92.22

FY End

9/30/2015

Current Date

3/10/2015

Current P/E

31.61

Assumptions Risk Free Rate

2.09%

Premium

8.00%

Beta

0.87

Cost of Equity

9.04% 4.03

Estimated FY 2017 EPS Estimated FY 2017 P/E

27.5x

Undervalued

0.43%

Dividend Growth Model Year 2015

Div. Paid Div. Remaining $ 1.00 0.32

PV Factor

PV of Dividends

0.559

0.95

$0.95

2016

1.52

1.559

0.87

$1.33

2017

1.82 Total

2.559

0.80

$1.46 $3.74

STARBUCKS VALUATION (SPRING 2015) 28

P/E AND EPS SENSITIVITY

EPS Est. 4.03 4.03 4.03 4.03 4.03 4.03 4.03 4.03 4.03 4.03 4.03 4.03 4.03

EPS Est. 3.43 3.53 3.63 3.73 3.83 3.93 4.03 4.13 4.23 4.33 4.43 4.53 4.63

P/E Est. 22.5x 23.5x 24.5x 25.5x 26.5x 27.5x 28.5x 29.5x 30.5x 31.5x 32.5x 33.5x 34.5x

P/E Est. 27.5x 27.5x 27.5x 27.5x 27.5x 27.5x 27.5x 27.5x 27.5x 27.5x 27.5x 27.5x 27.5x

Price $90.73 $94.76 $98.80 $102.83 $106.86 $110.89 $114.93 $118.96 $122.99 $127.02 $131.06 $135.09 $139.12

P/E Sensitivity ‐FY2017 PV Factor PV of Price $0.80 $72.71 $0.80 $75.94 $0.80 $79.17 $0.80 $82.41 $0.80 $85.64 $0.80 $88.87 $0.80 $92.10 $0.80 $95.33 $0.80 $98.56 $0.80 $101.79 $0.80 $105.03 $0.80 $108.26 $0.80 $111.49

EPS Sensitivity ‐FY2017 Share Price PV Factor PV of Price $94.39 $0.80 $75.65 $97.14 $0.80 $77.85 $99.89 $0.80 $80.05 $102.64 $0.80 $82.26 $105.39 $0.80 $84.46 $108.14 $0.80 $86.66 $110.89 $0.80 $88.87 $113.64 $0.80 $91.07 $116.39 $0.80 $93.28 $119.14 $0.80 $95.48 $121.89 $0.80 $97.68 $124.64 $0.80 $99.89 $127.39 $0.80 $102.09

PV of Div. $3.74 $3.74 $3.74 $3.74 $3.74 $3.74 $3.74 $3.74 $3.74 $3.74 $3.74 $3.74 $3.74

Total PV $ 76.45 $ 79.68 $ 82.91 $ 86.14 $ 89.38 $92.61 $ 95.84 $ 99.07 $102.30 $105.53 $108.77 $112.00 $115.23

PV of Div. $3.74 $3.74 $3.74 $3.74 $3.74 $3.74 $3.74 $3.74 $3.74 $3.74 $3.74 $3.74 $3.74

Total PV $ 79.38 $ 81.59 $ 83.79 $ 86.00 $ 88.20 $ 90.40 $ 92.61 $ 94.81 $ 97.02 $ 99.22 $101.42 $103.63 $105.83

STARBUCKS VALUATION (SPRING 2015) 29

PEG AND PVGO ANALYSIS

Date 2010 2011 2012 2013 2014 2015 2016 2017

EPS $ 1.27 $ 1.67 $ 1.84 $ 2.20 $ 2.75 $ 3.09 $ 3.44 $ 4.03

P/E 20.19 24.37 28.33 35.03 28.53 30.00 28.50 27.50

PEG & PVGO ANALYSIS 3‐Years Stock Price Growth 25.72 40.64 52.00 77.07 19.76% 78.33 17.88% 92.71 18.76% 97.96 15.87% 110.95 13.54%

PEG 1.77 1.60 1.60 1.80 2.03

PVGO $52.72 $47.95 $58.52 $59.93 $66.31

PVGO/ Stock Price 68.41% 61.22% 63.12% 61.18% 59.77%

STARBUCKS VALUATION (SPRING 2015) 30

DDM ANALYSIS—ALPHA

Alpha 5‐Mar‐15 30‐Apr‐15 31‐Jul‐15 31‐Oct‐15 31‐Jan‐16 30‐Apr‐16 31‐Jul‐16 31‐Oct‐16 31‐Jan‐17 30‐Apr‐17 31‐Jul‐17 31‐Oct‐17 31‐Jan‐18 Quarterly Annualized Required Alpha

($92.22) 0.32 0.32 0.36 0.36 0.36 0.36 0.44 0.44 0.44 0.44 0.50 92.61 1.77% 7.27% 9.04% ‐1.77%

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FCFE ANALYSIS

Net Income +Depreciation & Amortization +Change in Working Capital ‐Accounts Receivable ‐Inventory ‐Other Assets ‐Accounts Payable ‐Other Liabilities Operating Cash Flow ‐Capital Expenditures ‐Net Share Repurchases ‐Net Debt (Repayments) FCFE Cumulative Shares Outstanding FCFE Per Share PV Factor PV of FCFE Total PV of FCFE PV of 2017 Stock Equity Value Current Price Undervalued

FY 2015 2307 881 35 (64) (331) (43) 387 87 3,223 (1,400) (553) 0 1270 747.10 1.70 0.95 1.62

FY 2016 2548 990 124 (25) (143) (47) 244 95 3,662 (1,000) (507) 0 2155 741.60 2.91 0.87 2.54

FY 2017 3003 1,136 165 (26) (194) (50) 332 103 4,304 (1,000) 277 (400) 3180 744.60 4.27 0.80 3.42 7.58 92.61 $100.19 $92.22 8.65%

($92.22) 0.00 0.00 1.62 0.00 0.00 0.00 2.54 0.00 0.00 0.00 3.42 92.61 2.97% 12.42% 8.000% 4.42%

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INCOME STATEMENT

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BALANCE SHEET

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CASH FLOW STATEMENTS

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SUMMARY OUTPUT

0.132656458 0.214592077 0.347248535

Regression Sta s cs Mul ple R 0.618078998 R Square 0.382021648 Adjusted R Square 0.381529627 Standard Error 0.013071097 Observa ons 1258

SS 1 1256 1257

Significance MS F F 776.433653 0.132656458 8 1.9587E‐133 0.000170854

ANOVA df

0.000369037

0.03677056

Standard Error

0.000692038

Coeﬃcients Intercept

1.024595442

1.02

Lower Upper t Stat P‐value Lower 95% Upper 95% 95.0% 95.0% 0.06098937 0.0014160 0.0014160 1.875255945 7 ‐3.1958E‐05 34 ‐3.1958E‐05 34 0.95245695 1.0967339 0.95245695 1.0967339 2 31 2 31

27.8645591 1.9587E‐133

SPX %

B ETA

Regression Residual Total

REGRESSION

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CHARTS

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CHARTS

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CHARTS

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CHARTS

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SELECT NEWS ARTICLES [1]

Starbucks has launched a new delivery service for fans of its most premium coffee beans. The service will deliver the beans within three to ive days after they are roasted at Starbucks' Reserve Roastery and Tasting Room in Seattle. Customers can sign up for a monthly subscription to receive the small‐batch coffee straight from the roastery. Each month, subscribers will receive one 8.8‐ounce bag of beans. A one‐month subscription (one bag) costs $24 and a 12‐month subscription (12 bags) costs $288. By comparison, an 8.8‐ounce bag of Starbucks' premium Reserve blend ranges from $12.95 to $17.95. A one‐pound bag of Starbucks' Pike Place blend costs $11.95. "Starbucks Reserve Roastery subscriptions are — aside from visiting the Roastery and having our partners scoop the coffee right in front of you — the freshest, fastest and most innovative whole bean coffee experience in the market‐ place," Starbucks CEO Howard Schultz said in a release. Starbucks' opened the Seattle Reserve Roastery and Tasting Room in December. The company has plans to build 100 cafes globally that will exclusively serve Reserve coffee. Starbucks is also planning to start a beverage delivery service this year. The company is " inalizing plans for two distinct delivery models — one of which utilizes our own people, green‐apron baristas, and the other, which leverages the capabilities of the third‐party service, Schultz said in a call with ana‐ lysts last month. Members of Starbucks' loyalty program will be able to request delivery through Starbucks' new mobile order and pay app, which will be rolled out nationwide this year.

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SELECT NEWS ARTICLES [2] By Julie Jargon Starbucks Corp. aims to double sales from its food business in the U.S. over the next ive years and become more of an evening food‐and‐wine destination as it continues its push to be more than just a coffee chain. The Seattle‐based chain known for its java in recent years has removed the word “coffee” from its logo and expanded food beyond its traditional breakfast pastries. During an investor conference on Thursday in which the company is expected to lay out its growth strategies for the next ive years, Starbucks plans to announce a target for annual reve‐ nue from food in the U.S. market to double to more than $4 billion by iscal 2019. The nationwide rollout of La Boulange baked goods and sandwiches, completed earlier this year, has helped fuel sales growth and the company plans to expand its offerings at lunch to attract more customers at a slower time of day. “We now understand better than ever before how to develop a larger food business in our stores in the morning and in‐ creasingly at lunch,” Starbucks Chief Operating Of icer Troy Alstead said in an interview. Starbucks also plans to dramatically expand its evening food‐and‐alcoholic beverages program. It now has 32 cafes with such offerings, and plans to increase that over the next ive years to more than 2,700—equal to nearly a quarter of its more than 11,000 current U.S. stores. Some Starbucks cafes in Chicago, Seattle, Portland, Ore., and Los Angeles offer small plates of cheese, vegetables and latbread pizza, along with desserts, wine and beer after 4 p.m. “The oppor‐ tunity is much bigger than we thought it would be,” Mr. Alstead said. The increased focus on food comes at a time when Starbucks and other mature restaurant brands have been trying to igure out how to juice sales in the U.S., where growth from opening new restaurants is limited. Some chains have add‐ ed entirely new meal times while others have added new choices across the day. Taco Bell, a unit of Yum Brands Inc., this year began offering breakfast, which has helped boost its results. But adding to the menu can back ire. McDonald’s Corp., for example, has suffered from slow service as a result of bulking up its menu with offerings including lattes and sandwich wraps. Some analysts say Starbucks isn't immune to the same problems, with its menu having increased in the last ive years to 255 items from 181. Domestic traf ic growth has slowed at Starbucks, but the company attributes that to customers’

STARBUCKS VALUATION (SPRING 2015) 42

SELECT NEWS ARTICLES [2] ‐ CONTINUED

migration to online shopping and not to an increase in menu items. Starbucks plans to speed service by offering new mobile ordering and payment technology that will enable customers to place orders before stepping in the cafe. The new app launched in Portland, Ore., on Wednesday and is scheduled to be rolled out across the country next year. Overseas, Starbucks still has a lot of room to grow by opening new cafes. Four years ago, Starbucks said it would have

STARBUCKS VALUATION (SPRING 2015) 43

SELECT NEWS ARTICLES [3]

By Josh Beckerman Starbucks Corp. unveiled plans to take full ownership of its Japanese operations for more than $900 million, part of a two‐step effort that would strengthen the coffee chain's control of its second‐largest market. The company plans to acquire the remaining 60.5% stake in Starbucks Coffee Japan Ltd.that it doesn't already own, irst buying out partner Sazaby League for about $505 million and then public shareholders for an estimated $408.5 million. Starbucks said the acquisition would position the company to introduce new concepts in Japan, such as Teavana, its chain of tea locations. Starbucks Japan was formed as a joint venture partnership in 1995. The venture has more than 1,000 stores and about 25,000 employees. Starbucks said Sazaby approached the company about selling its stake over the summer, in advance of the expiration of Starbucks Japan's retail franchise rights. The existing license agreements are set to expire in March 2021 and con‐ tain no provision for auto‐renewal. Starbucks, which opened its irst store outside of North America in Tokyo's Ginza district nearly 20 years ago, said it expects the deal to immediately add to its results, excluding certain items. The transactions are expected to be fully completed in the irst half of calendar 2015. As of June 30, Starbucks had 20,863 world‐wide locations. Starbucks said the payment to public shareholders represents a 4.7% premium to Monday's closing stock price, and a 51.8% premium to the price Starbucks is paying for Sazaby's shares. In July, Starbucks reported its 18th consecutive quarter of same‐store sales gains of 5% or more, on top of a 23% in‐ crease in earnings. Earlier this month, the company outlined plans to expand with new formats including the Star‐ bucks Reserve Roastery and Tasting Room, and an "express" format targeting fast service in urban areas. The compa‐ ny also introduced a new line of single‐origin coffees sold at supermarkets.

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REFERENCES

Hoovers Ibisworld Starbucks Company Website Wall Street Journal Bloomberg Valueline Yahoo Finance Reuters Google Finance Morning Star Forbes Statistica Stock Analysis Nasdaq Payment Source Business Insider Market Realist Seeking Aplha New York Times CSI Market Agrimoney World Bank International Coffee Organization Financial Times CNBC Tech Crunch

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