This article was written by Cole Winston, a Financial Analyst at I Know First.



Starbucks Stock Prediction

Summary

The Coffee Industry

Starbucks History and Governance

Business and Financial Performance

Price Action: Value Play

Bullish Long-Term Forecast

The Coffee Industry

For quite some time, Starbucks (NASDAQ: SBUX) has been stuck in range-bound price action as market participants have been contemplating and evaluating the value that SBUX deserves to be priced at. What the market is missing, however, is the unique place that SBUX holds in the business lines in which it operates, making SBUX a value play ripe for investment over the long-term.

Understanding Starbucks’ unique position requires a quick history lesson on specialty coffee. The modern spread of coffee production and consumption can be delineated into three waves: the First Wave, the Second Wave, and the Third Wave.

The First Wave of was driven by businesses seeking profits, and who were concerned with, and responsible for, transforming coffee into a major commodity. These producers ultimately oversaw the domestication of coffee, as it were, and its introduction into homes and offices across the United States. These brands were known for being relatively bitter, bland, and weak-tasting. In essence, these players brought coffee to the broader world. Enter the Second Wave.

Unlike the First Wave, the Second Wave was artisan-driven as a response to the First Wave’s lack of quality, whereby the focus shifted towards coffee origins and roasting styles; a phenomenon that still characterizes the Third Wave today. Players in this space created innovative and new methods for improving coffee quality and flavor, and popularizing modern widespread beverages like espressos and lattes. They also educated consumers about the origins of their coffee beans, as well as their methods of roasting. Starbucks is the one among Second Wave producers that has risen to the very top, championing the industry and solidifying its place globally as a go-to coffee source. Third Wave producers, although different, very highly reflect the Second Wave to a point of being indistinguishable.

Starbucks holds a special position among coffee producers. It was only able to reach this position by always remembering and reflecting on its core purpose.

Starbucks History and Governance

Starbucks has always been a business wholly-concerned with fostering genuine and intimate relationships with customers, creating an environment with a customer experience unmatched by anyone else in the industry. The key risk associated with its success, however, was managing its rapid growth and aiming for ubiquity without brand dilution. Based on this, there have been four phases in the company’s history.

From its founding in 1971 until Howard Schultz joined as Director of Retail Operations and Marketing in 1982, Starbucks was entirely focused on selling coffee beans, rather than actual coffee drinks. While travelling in Italy and witnessing the very close and personal connection people had with coffee and the community culture embraced by various Italian coffee shops, Schultz had the epiphany that Starbucks should, in fact, move into selling coffee beverages and not just beans. After struggling to convince the co-founders that he had seen the future in Italy, they eventually let him establish a coffee bar in a new Starbucks store that was opening in Seattle. The massive success of this new store demonstrated to the original founders that they didn’t want to go in the direction Schultz wanted to take them; growth.

So in 1987, Schultz left to start his own coffee business: Il Giornale. Very strategically, Schultz then purchased Starbucks, becoming their CEO and Chairman in the process. What America was witnessing at this point was Starbucks’ and Schutlz’s mapping out of the Second Wave of Coffee, as outlined above. From this point on, Schultz continued to execute the strategy of growth without brand dilution in a very big way, expanding the number of stores and products exponentially and unabated.

This proved an immensely difficult task. In Jobs-esque fashion, Schultz stepped down as CEO in 2000 in light of SBUX having grown too quickly, causing stores to lose their unique appeal and become more commoditized. This only continued in the time Schultz was gone from the company, also in Jobs-esque fashion. Schultz ultimately returned as CEO in 20008, and sent Starbucks on its current path.

This time around, Schultz was able to steer Starbucks in the direction of retaining its place as a premium producer with many more products and many more store locations in many more countries, all the while never diluting the brand image and customer experience that Schultz and his Starbucks team had dedicated so much blood, sweat and tears to establish.

As is the case with any company that is heavily reliant on one person, there was widespread belief that Starbucks would be nothing without Schultz at the helm. This is a major concern now that Schultz has resigned as CEO permanently, retaining his Executive Chairmanship nevertheless. However, when one examines the board of directors and newly-minted CEO Kevin Johnson, this risk is being managed. Together, the board and executive management collectively possess close to 150 years of experience with Starbucks, and even more time spent in the customer service, finance, consulting and other business sectors. And Johnson, having been groomed for a long time by Schultz, has developed such a strong relationship with the former CEO that he is well-positioned to continue the direction Schultz has taken Starbucks. Johnson himself has expressed that two categories of companies are the source of inspiration as CEO: huge companies that have continued to innovate as they’ve scaled their business, and startups that are revolutionizing their industries. From a management perspective, the future is bright for SBUX.

Business and Financial Performance

All of the above is just talk without the data to back it up.

Sales has continued to grow as in the past, increasing 11.3% year-over-year from $19.16 billion in fiscal year 2015 to $21.32 billion in fiscal year 2016, and healthily above the 5-year average. Due to the absence of any serious competitor brand in the high-end coffee market segment, and in light of Starbucks’ plans at increasing locations in developing markets as these markets continue to grow wealthier and have more money to spend, there is lots of room left for top-line growth.

Management has demonstrated its ability to manage costs and expenses, yielding a FY 2016 Gross Margin of 60%, FY2016 Operating Margin of just under 20%, and EBIT Margin similarly 20%.

Bottom-line profitability holds steady at $2.82 billion, growing in line with historical trends and only set to expand in light above the above expansion plans. Earnings-per-Share (EPS) has also continued its growth to $1.90 per share, which is a largely positive signal to market participants.

Starbucks’ cash position is very strong, demonstrated by a 39% increase in Cash and Cash Equivalents to $2.13 billion, growth of 65% in Short-term Investments to $134.4 million, $4.58 billion in cash flows generated from operations, and a net increase in Net Cash Position (above) even in light of Cash Flow from Financing Activities and Cash Flow from Investing Activities both being net uses of cash. Capital Expenditures are likely increasing steadily, having increased year-over-year from $1.3 billion to $1.4 billion. This is a reflection of the long-term orientation of management and their willingness to reinvest profits in the Starbucks business.

Equally encouraging were shareholder returns. This past fiscal year, $3.2 billion was returned to shareholders through a combination of share repurchases and dividend payments, compared to $2.4 billion returned the prior fiscal year.

All in all, the data speaks for itself.

Price Action

As demonstrated below, it appears as if the market has not recognized the value inherent in the Starbucks business and is threatened by the resignation of Howard Schultz from his revered CEO title.

From late 2014 until mid-to-late 2015, SBUX bulls took the company’s stock price increasingly higher, marching uninterrupted until uncertainty facilitated the entrance of the market into the multi-year sideways market that continues to plague SBUX shares.

As mentioned above, a large block of uncertainty has overtaken the market as Howard Schultz originally announced that he will be stepping down as CEO, and then actually doing so. However, because his successor has been groomed and is well-prepared to assume the mantle and responsibilities of CEO, the market might very well be wrong in their taking the SBUX stock price lower. This represents a buying opportunity in line with the I Know First algorithmic forecast of the stock.

Chart Guide: white candles represent the close being higher than the open (an up candle), black candles represent the open being higher than the close (a down candle), red “E” circles represent earnings releases, blue “D” circles represent dividends announcements, green “S” circles represent stock splits, the top chart represents monthly candles, the middle chart represents weekly candles, the bottom chart represents daily candles, and the price data is sourced from BATS (an electronic exchange platform).

Bullish Long-Term Forecast

When everything is considered, it becomes clear why the I Know First algorithm is bullish on SBUX over the long-term, and why the market is currently not discounting these fundamentals in the price of SBUX shares. For this thesis to manifest itself, it will be crucial to continuously monitor how the expansion plans of Starbucks progress, and how freshly-minted CEO Kevin Johnson carries both himself and the company.



The I Know First algorithm is bullish on SBUX over the long-term both on a 3-month and yearly basis. In light of the recent poor performance of SBUX shares, SBUX is currently being predicted by the I Know First algorithm as a value play waiting to be recognized by other market participants. Once enough time has passed for CEO Johnson to prove his worth and capabilities, and maintain or extend the Starbucks legacy, the market will eventually correct its emotional reactions.

I Know First was previously bullish on SBUX on November 7th, 2016. To subscribe today click here.

I Know First Algorithm Heatmap Explanation

The sign of the signal tells in which direction the asset price is expected to go (positive = to go up = Long, negative = to drop = Short position), the signal strength is related to the magnitude of the expected return and is used for ranking purposes of the investment opportunities.

Predictability is the actual fitness function being optimized every day, and can be simplified explained as the correlation based quality measure of the signal. This is a unique indicator of the I Know First algorithm, allowing the user to separate and focus on the most predictable assets according to the algorithm. Ranging between -1 and 1, one should focus on predictability levels significantly above in order to fill confident about/trust the signal.