Executive Summary



Estimating the Value of Starbucks CorporationBusiness Valuation – Spring 2017Team Snapchat:Lara Dixon, Alfonso Aguilera, Ben Nematzadeh, Donald Horton TOC \h \u \z Executive Summary PAGEREF _30j0zll \h 21. Economic Environment PAGEREF _1fob9te \h 42. Industry Analysis PAGEREF _3znysh7 \h 43. Company Description PAGEREF _2et92p0 \h 54 Valuation Technique: DCF Analysis PAGEREF _tyjcwt \h 64.1 Cost of Capital (WACC) PAGEREF _1t3h5sf \h 64.1.1 Cost of Debt (rd) PAGEREF _4d34og8 \h 74.1.2 Cost of Equity (re) PAGEREF _2s8eyo1 \h 94.1.3 Capital Structure PAGEREF _17dp8vu \h 124.2 Creation of Free Cash Flow Projections PAGEREF _ac2qxloeb983 \h 124.2.1 Base Year Free Cash Flow PAGEREF _lnxbz9 \h 134.2.2 Future Free Cash Flow (FFCF) Projections PAGEREF _35nkun2 \h 154.3 DCF Valuation PAGEREF _1ksv4uv \h 205 Valuation Technique: Relative Valuation PAGEREF _44sinio \h 215.1 Choice of Comparables PAGEREF _2jxsxqh \h 215.2 Adjustments PAGEREF _z337ya \h 226. Summary of Valuation PAGEREF _3j2qqm3 \h 23Appendix25Exhibit A - Interest Coverage Table25Exhibit B - Altmans-Z Table26Exhibit C - Average Bond Spread26Exhibit D - Starbucks Long-term Debt Schedule (Source: Starbucks 2016 10K)27Exhibit E - Present Value of Starbucks Debt, Starbucks Debt Repayment Profile (incl. operating leases)27Exhibit F - Daily Regression Output - Starbucks Returns and S&P 500 Index Returns28Exhibit G - 5-year Monthly Daily Regression Output - Starbucks Returns and S&P 500 Index Returns28Exhibit H - 2-year Monthly Daily Regression Output - Starbucks Returns and S&P 500 Index Returns28Exhibit I - Unlevering and Re-levering Starbucks Beta29Exhibit J - Key 2017 Revenue Growth Drivers per Region29Exhibit K - DCF Model and Driving Assumptions30Exhibit L - Perpetuity Growth Rate Calculation Using Forecast GDP30Exhibit M - Calculating Equity Value per Share Using Each Estimate of EV30Exhibit N - Industry Analyst Starbucks Target Share Price31Exhibit O - Sensitivity Analysis: Change in EV & Equity Value per Share driven by changes in WACC and/or ‘g’31Starbucks: ValuationExecutive SummaryThe purpose of this report is to discuss in detail our approach to arriving at an estimate of the valuation of Starbucks Corporation, a company that operates in the Quick Service Restaurant (QSR) industry and has grown to become a global premium brand leader with more than 25,000 stores in 75 different countries. An in-depth review into the company’s operations, growth plans, competition and external environment has aided our assessment of the key information required to generate robust valuation estimates when used in conjunction with key business valuation techniques. Established in 1971 selling made to order coffee, Starbucks has expanded to sell ready-to-drink (RTD) coffees, ready-to-eat (RTE) Foods, snacks, and teas. Starbucks has endured the most recent global recession and even achieved a 10% compound annual growth rate since 2012. Going forward, major growth plans have been announced in two key regions, the America’s and the Asia Pacific (ACAP) regions. Starbucks has been aggressively expanding into the ACAP market in particular, which currently contributes 15.58% of total revenues. Company management have even admitted the ACAP market, specifically driven by Chinese demand, may one day contribute the majority of Starbucks’ revenue. Recently, however, market and macroeconomic conditions in both the Americas and ACAP regions respectively suggest ongoing growth of 10% may not be achievable. Same store sales growth in established stores in the Americas, for example, are the lowest since 2009, and lower GDP forecasts in key APAC economies could prove another limiting factor. Industry analysts also consider the QSR market to be highly fragmented, saturated and incorporating a high level of product substitutes. Some competitors in the overall industry include Wendy’s, Yum Brands International, Jack in the Box, and Domino’s Pizza, among others, each fighting for market share. Despite the competitive landscape, Starbucks is expected to continue on a growth trajectory. Starbucks aims to open a further 5,000 stores by 2019 and that its growing product line of consumer food and drink choices will help maintain its leadership position. This position will be reliant on the company’s continued investment in some unique assets: employee (partner) engagement, menu expansion, product innovation, loyalty programs and new technology. By providing healthcare and tuition reimbursement Starbucks aims to attract high quality and committed “partners” which consumers will identify as core to developing an unrivalled, experiential store atmosphere. Starbucks continues to invest in a strong digital ecosystem (mobile loyalty programs, digital payment applications, and mobile gift cards) and menu improvements to boost customer convenience, appreciation, in-store spending and retention. We employed two approaches to determine the enterprise value of Starbucks; Discounted Cash Flow (DCF) and Relative Valuation. DCF is based on the premise that the value of a company is the present value of all future free cash flows of the company. The present value of future cash flows is obtained by discounting the future cash flows a firm’s weighted average cost of capital (WACC). The sum of the present value of future free cash flows is the DCF estimate of Starbucks value. The WACC is defined as the required rate of return for a firm and, therefore, the rate of return one should expect per annum upon investing in the company. The WACC is reliant on multiple factors each of which are specific to the company, such as a firm’s capital structure (proportions of debt and equity financing) and investors’ expected rates of return. As such, it is highly likely the WACC for Starbucks will not be identical to that of its competitors. Furthermore, it is difficult to estimate all factors influencing WACC precisely. Nevertheless, in this report we employ and discuss multiple data sources and methods to instill confidence in our calculations of all components required to estimate Starbucks' WACC.Once we established our estimate of WACC as 7.11%, the focus of our discussion turns to the estimation of Starbucks’ future free cash flows (FFCF). FFCF is defined as a company’s net operating profit after tax (NOPAT) less capital expenditures and working capital investments. We are interested in FFCF because this measure represents cash (value) generated by Starbucks once Starbucks has spent the necessary money it needs in order to maintain or expand its asset base. Sales growth drives our estimates of operating income after tax, capital expenditures and the change in working capital. We estimate each of these factors using historic averages from 2011 to 2016 (latest year), and then adjust each factor in 2016, for example to account for any one-time deviations from historic trends. We project 2017 sales by projecting same store sales for a combination of existing stores and new stores opening in 2017. Our 2017 growth rate is estimated to be ~8.5%. As projected revenue drives our estimates for capex and net working capital adjustments it is, therefore, critical we are comfortable with our revenue projections.When valuing a company, we make the key assumption that we are valuing FFCF out to eternity. Despite Starbucks’ recent growth being higher than global GDP growth, we cannot assume this level of growth shall continue forever. We have made detailed FFCF projections for the period 2017-2022, however beyond this period we assume Starbucks FFCF growth is aligned with global GDP growth estimates. Data from the International Monetary Fund, World Economic Outlook Database, April 2017 aided our calculation of an appropriate growth rate beyond 2022. Once all FFCF were estimated we discounted each annual FFCF back to a present value of the cash flow using our estimate of WACC. We apply a perpetuity growth method formula to calculate the value of FFCF beyond 2022, which is also known as the terminal value (TV). The sum of the discounted annual FFCFs, including that of the TV, was ~$105B and represents our DCF estimate of the enterprise value (EV) of Starbucks. Our Relative Valuation methodology involves the use of comparable companies, whereby the value of Starbucks is compared to the value of the similar companies as assessed by the market. One major difficulty with using this approach for Starbucks is the lack of direct or close comparable companies to Starbucks. Nevertheless, we filtered companies operating in Starbucks’ industry by a set of three criteria (annual revenue, operating margin and five-year growth forecast) and obtained a set of five close comparable companies. For this comparable set we calculated three valuation metrics for each company and obtained the median valuation for the comparable set. The three valuation metrics include: EV/Revenue, EV/EBITDA, and EV/EBIT. We use EV in the calculation of this multiples as EV is a more comprehensive measure of the market value of a company than equity value because it accounts for claims by all claimants on the company, i.e. debt holders and equity holders. As such, EV is a more accurate measure of the theoretical price to acquire a company debt free. We compared the median expected growth rate, EBIT margin and revenue for the comparable company set to Starbucks own projected growth rate, EBIT margin and LTM revenue and used any deviations between Starbucks and the comparable set to apply an adjustment to the median valuation multiples. The purpose of this adjustment was to ensure each multiple was a better match to Starbucks given Starbucks’ size and forecast growth. By multiplying the adjusted valuation multiples by the relevant Starbucks' financial statistic (Revenue, EBIT or EBITDA) we derived three additional estimations of Starbucks EV. The three values ranged from ~$98B to $117B. The key output from this report is four estimates of Starbucks EV. By adding back Starbucks cash balances and subtracting the present value of company debt from each EV estimate we were able to determine implied equity values for the company. Dividing each equity value by the total number of Starbucks shares outstanding (1,457.4m) allowed us to demonstrate four estimates of Starbucks equity value per share. The average equity value per share using our estimation techniques was $68.23 and the median $68.24. Such estimations are approximately 12% higher than Starbucks’ market share price of $60.87 (May 11th, 2017). Our estimates are also higher than analyst consensus, albeit within the range of analyst target prices. By its very nature, business valuation is difficult to estimate with accuracy. All valuation techniques employed involve a high degree of estimation in order to forecast future events which is inherently difficult. As such, our estimates of Starbucks’ value, despite being driven by our best efforts to forecast the unknown, will differ, perhaps considerably, from other estimates due to variations in key assumptions which drive future FCF. Whether our revenue growth is too conservative, or perpetuity growth rate too optimistic, only time will tell and for now we feel our estimates to be as good as any other. 1. Economic EnvironmentThe global economic environment is filled with uncertainty. According to the World Economic Forum’s Insight Report there are five key trends determining global development: rising income and wealth disparity, climate change, increasing polarization of societies, rising cyber dependency, and an ageing population. Tied to the aspect of rising income and wealth disparity is lower than expected global productivity. Especially concerning is that whilst most economies around the globe have concluded the recent recession period is complete, recent actual GDP growth rates are lower than expected. Most important to Starbucks, are the North American and Asia Pacific (APAC) markets, both of which account for and are expected to continue accounting for a significant portion of global revenues. Uncertainty in the US and APAC markets, specifically regarding forecast GDP growth concerns in China and lower than expected growth rates in the US, have been a source of contestation regarding the economic strength of these two regions. Nevertheless, US and Chinese GDP growth is trending positive which is beneficial to Starbucks and the industry they operate in.2. Industry AnalysisThe industry Starbucks operates in is recorded as Eating Places (SIC 5812) by the Standard Industry Classification (SIC) system, or as a limited service restaurant (NAICS 722513) by the North American Industry Classification (NAICS) System. Slowly improving macroeconomic conditions are expected to improve revenues for these industries overall as they are considered cyclical and will tend to follow the trends of the economy. Close competitors to Starbucks are not easy to find, however the closest may include Wendy’s (WEN), Jack in the Box (JACK) Domino’s Pizza (DPZ), Panera Bread (PNRA), and Yum Brands (YUM). These establishments primarily engage in the retail sales of prepared food and drinks for on premise or immediate take-out consumption. The threat of new entrants to the market is moderate-high as there are few, if any, barriers to new company entry. Starbucks operates in a subset of the Eating Places industry known as Quick Service Restaurants (QSR). Analysts consider QSR to be a highly saturated and fragmented market with many competitors and a vast array of consumer choices. The threat of substitutes is, therefore, considered high. In this subset, the Starbucks brand positions itself as the coffee beverage leader in the premium product category. In the US, the market for premium coffee is considered mature while, in emerging economies the industry remains in the growth stage. Starbucks faces intense competition, which is something that analysts and Starbucks both agree on. According to the 10K, Starbucks management perceive specialty coffee shops and quick service restaurants as direct competitors within the US. Internationally, mature QSR companies are considered their main competitors. Starbucks also acknowledges direct competition in their channel development business unit.Demand determinants for premium coffee include disposable income, trends in per capita coffee consumption, and health perceptions regarding Starbucks products. Buyer power is moderate with no large players able to affect overall industry pricing. Profitability drivers in the industry primarily revolve around coffee bean pricing. Historically, bean prices have been volatile but typically increase as demand rises. Although low given global demand, coffee prices are expected to increase in coming years with rapid forecast demand growth in Asia considered a major driver of demand and coffee price growth.3. Company Description Starbucks (SBUX) was established in Seattle, Washington in 1971. Starbucks’ principal line of business comprises the operation of over 25,000 specialty coffee stores across the globe. Company-operated stores accounted for 79% of Starbucks' $22.2B revenues in 2016, and licensed stores generated 10%. Starbucks' consumer packaged goods (CPG) segment achieved 8% of total revenues and comprises the sales of packaged beverages to grocery, warehouse clubs and specialty retail stores. Starbucks also supplies coffee and tea related products to institutional food service companies that service operators in education, healthcare, hotels etc., and this unit contributed the residual 3% of Starbucks' revenues. Starbucks' revenues have increased at a 10% compound annual growth rate (CAGR) since 2012. Over this period, company operated store revenues grew at 9.8% CAGR whereas licensed stores and CPG/Food service revenues grew at 12.1% and 8.6% CAGR respectively.According to the company’s quarterly earnings call, Starbucks has dominance in its position with the closest competitors selling discount coffee products. Leveraging product differentiation and their premium product mix, Starbucks is expected to maintain its dominance as the world’s leading coffee retailer with plans to reach 30,000 stores by 2019. With a high level of competitive rivalry, the company focuses on offering an experiential purchase and unique in-store ambience that competitors will find difficult to imitate. Part of this experience includes superior customer service in a well maintained, relaxed atmosphere with free wi-fi. These factors have combined to create a globally recognizable brand operating in over 60 countries and achievement of approximately 40% market share in the United States. The company targets prime real-estate and high traffic locations for new store openings which ties into to its brand positioning.A few aspects unique to the company, compared to the industry overall, is their human resource management, use of technology, and social activism. Employees of Starbucks are known to receive excellent training, stock options, retirement options, tuition reimbursement, and healthcare options while operating in a healthy culture. The use of technology allows Starbucks to target, analyze, and expand its customer base while increasing the frequency of customer visits. This has proven extremely successful in recent years as consumers adopt technology as a part of their daily lives, share gift cards with friends, and load up loyalty accounts before redeeming them for purchases. Finally, Starbucks is one of the few companies to participate in activist movements reflected by modern society. According its customer base, Starbucks does this successfully by picking movements largely considered to be in the best interests of society. The company frequently deals with misinterpreted marketing campaigns and messages, but the brand has always managed the publicity well and is one of Starbucks most recognizable attributes.4 Valuation Technique: DCF Analysis Outlined below is a detailed description of the two approaches utilized to determine the value of Starbucks, Discounted Cash Flow (DCF) and Relative Valuation. DCF is based on the premise that the value of a company is the present value of all future free cash flows of the company. The present value of a cash flow refers to the current worth of a sum of money that is expected to be received in the future. To arrive at the present value, all future free cash flows must be discounted back to today’s value using an appropriate discount rate. This is shown mathematically in Equation 4.1 below. Equation 4.1whereby:n = The time period between now and the future cash flow in number of years. CFn = Cash flow for period n. In the context of the valuation of a company, the cash flow is free-cash-flow (FCF). FCF is the cash generated from the normal operations of a business, and that is available to its creditors and owners. r = Discount rate. For a company, this rate represents the level of perceived risk by investors.DCF = The sum of the present value of the future free cash flows (FFCF) for a company is its valuation.The purpose of discounting future cash flows is to account for the fact that money received today can be invested today and earn a return in the future, thus $100 today is worth more than $100 received in one year. In relation to a firm, all future free cash flows are discounted at the firm’s weighted average cost of capital (WACC). Thus ‘r’ = WACC. The WACC is defined as the required rate of return for a firm and, therefore, the rate of return one should expect per annum upon investing in the company. 4.1 Cost of Capital (WACC)As previously discussed, the discount rate used for future annual FCF is the WACC, which is determined by evaluating the cost and proportions of both debt and equity for the company. The WACC is calculated as follows: Equation 4.2To install confidence in our WACC estimation we have sourced data from credible sources to calculate estimates for each component of Starbucks' WACC. These sources include. Starbucks’ 10Ks 2011-2016, Bloomberg, Compustat, the Federal Reserve Economic Data (FRED) and reputable industry analysts. The process followed to estimate each component is discussed in detail below. 4.1.1 Cost of Debt (rd)The market value of debt (D) in equation 4.2 refers only to the long-term debt -- debt that has a maturity greater than one year -- and includes known future commitments to operating lease payments. The cost of debt (rd) reflects the interest rate that Starbucks needs to pay debt providers. This value reflects the perceived risk or creditworthiness for these providers to lend money to the company. The yield (or return) on bonds (long term loans) depends on the bond rating of a company, the higher the rating the lower the perceived risk and lower the cost of debt. Our first step towards confirming the cost of debt was to determine the bond rating of Starbucks. We describe below three approaches (A, B & C) used to determine our estimate of Starbucks’ bond rating. Interest Coverage ratio: One way to measure the solvency of a company is to calculate the ratio of Earnings Before Interest and Tax (EBIT) to the interest expenses (INT) from debt obligations (long term notes and leases). This ratio EBIT/INT is the “Interest Coverage ratio”. The relevant values of EBIT and INT from Starbucks fiscal year ending October 2016 are shown in Table 0:Table 0: Starbucks’ Interest Coverage Ratio We use this 3.198 EBIT/INT value and map it to an Interest Coverage Statistics table (Exhibit A) which shows, amongst other statistics, the median and average interest coverage ratio for each of the different credit ratings (AAA → CC). Upon review, Starbucks’ 3.198 value corresponds most closely to a bond rating of BB-.Altman's Z-score: Altman’s Z-Score is another method used to determine an appropriate bond rating for Starbucks. Altman’s Z is a credit-strength test whereby a lower score indicates a higher probability that a company is headed towards bankruptcy. A score below 1.8 is considered extremely risky while an Altman’s Z-Score above 3 predicts a company will not go bankrupt. The score is determined by calculating 5 variables (X1-X5) for Starbucks and taking the sum of each variable multiplied by a specific predetermined weighting. The equation is 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1X5. X1 = working capital divided by total assetsX2 = retained earnings divided by total assetsX3 = earnings before Interest and Taxes (EBIT) divided by total assetsX4 = the market value of company equity divided by liabilitiesX5 = net sales divided by total assets. Table 1 identifies the five variables as they relate to Starbucks financial performance and confirms Starbucks’ Altman’s Z score to be 9.355, which is an extremely strong position for any company.Table 1: Starbucks Altman’s Z calculationExhibit B shows a suite of Altman Z statistics calculated for each of the different credit ratings (AAA → CC). By comparing Starbucks Altman’s Z score to this table, we note the closest median match to Starbucks is an A+. Starbucks' Comparable Ratings: The market has already determined the bond rating of companies comparable to Starbucks. We selected a set of comparable companies (Table 2) as being companies of similar (closest) size as Starbucks and offering competing products. We have reviewed each comparable company credit rating as our third approach to obtaining a satisfactory estimate for Starbucks credit rating. Table 2: Credit Ratings of Starbucks' Comparable CompaniesUsing a simple point-system for each bond rating, the average rating for this comparable set is BB. Starbucks' Ratings Calculation: At this point we have three different bond ratings to consider for Starbucks. The Interest Coverage and Altman's Z tables resulted in a wide rating differential (A+ ? BB-). The limitation of using these approaches is that the values calculated for Starbucks do not match specific values in the corresponding tables. And the comparable companies table indicates a lower rating range of B ? BBB, and an average of BB. The peer groups include McDonalds and Whitbread Group (both BBB), however given Starbucks’ scale, performance above its peers and strong growth prospects (as outlined in sections 1-3), Starbucks warrants a higher rating than its peers, including those that are BBB. After taking all approaches into account, we have assigned Starbucks an A- rating rather than a BBB. Bond Spreads Data TableThe next step to determine the cost of debt is to assign interest rates to the A- bond rating, being to calculate a specific rate for each debt maturity (the period of time from now until the bond is repaid). The interest rate can be broken down into two components, the risk-free rate (Rf) and the risk premium assumed for companies of a specific bond rating. The risk-free rate represents the interest rate paid by an entity that is considered to be incapable of defaulting; this ‘entity’ is widely considered to be the U.S. government. Bonds issued by the U.S. government are called treasury bills. Using recent Standard & Poors ratings agency data from Bloomberg we created an Average Bond Spread table (Exhibit C). This table highlights the risk premium for different credit ratings (AAA → BBB) at specific debt maturities. The interest rate for each maturity of Starbucks’ bonds is simply the sum of the treasury yield (final row in the table) and the risk premium for the A- rating row.Weighted Average Cost of DebtStarbucks’ 2016 10K confirms the company issued long-term debt with different maturities and, thus, different costs (interest rates) are associated with each tranche of its long-term debt. Our next step requires that we calculate the weighted average cost of all debt issued. Table 3 shows the calculations and accompanying explanation used to derive an estimated weighted average cost of debt of 2.5%Table 3: Weighted Average Cost of Debt The “Debt Value” for each maturity is the sum of the face value and the undiscounted lease obligations for the matching maturity. These lease payments are added because they represent interest-like debt obligations that the company must make beyond the current period (the next fiscal year).The Total Debt Value is the sum of all debt values. The Weighting is the ratio of each debt value versus the total debt value. The Cost of Debt for each maturity is simply the sum of the treasury yield and the risk premium for the A- rating row (calculated in the previous step).The Weighted Cost of Debt is the product of Weighting and Cost of Debt. Finally, the Weighted Cost of Debt for all debt is the sum of the Weighted Cost of Debt.Value of Starbucks' DebtTo calculate the future debt cash flows, we calculated all interest (coupon) payments, principal repayments (Exhibit D) and lease obligations for all years until the year the final tranche of existing long term debt is scheduled for repayment. Exhibit E shows a repayment profile for Starbucks debt cash flows, including future annual operating lease commitments. To calculate the present value of all future debt, the annual sum of long-term debt and lease cash flows have been discounted using the weighted average cost of debt, 2.5%. As also shown in Exhibit E, the present value of Starbucks debt is estimated as $9,917.6 million, being the sum of the discounted debt related cash flows.4.1.2 Cost of Equity (re)re in Equation 4.3 represents the cost of equity, which is the rate of return a company theoretically pays to its equity investors (shareholders) to compensate them for the risk they undertake by investing their capital in the business. In other words, re is the return shareholders require or expect for their investment in a company. re is calculated as follows:re = Rf + β*(Rm - Rf)Equation 4.3where:re = return on equity Rf = return on 30-year treasury (risk free rate)β (Beta) = a measure of the sensitivity/volatility of Starbucks’ stock returns relative to overall market indices returns. Rm = the expected return of the marketCalculating Beta In general, a beta value of less than 1 indicates that asset returns are less volatile than the market, while a beta greater than 1 indicates that asset returns are more volatile than the market. The calculation of beta is somewhat subjective. However, to obtain a defensible value we have conducted multiple regression analysis, each of which looks at the correlation (sensitivity) between the daily returns of Starbucks, and that of a market index such as the Standard & Poor's 500. The correlation is obtained from a least squares linear regression (a line through the data points that best represents the data). The slope of the regression line provides an estimate for beta. We assessed Starbucks beta using three regression models:1 year Daily Regression: This approach regressed daily Starbucks and market returns using data over a 365-day (one year) period.5-year Monthly Regression: This approach regressed monthly Starbucks and market returns using monthly returns data over a five-year period.2-year Weekly Regression: This approach regressed weekly Starbucks and market returns using weekly returns data over a two-year period. The ‘Return on S&P 500’ coefficient represented our beta estimate for each regression (Exhibit F, G and H). In addition to the three regression based beta values we obtained Beta estimates from three reputable financial analyst websites for consideration. As shown in Table 4, the median of all six Beta estimates was 0.771. Table 4: Set of Estimated Beta for StarbucksEstimating Starbucks’ Beta using Comparable Companies:One final technique used to find an appropriate estimate of beta involves a review of beta estimates for a set of comparable companies. The process is not as simple as taking the average of the betas in the comparable set because the beta for each comparable is a ‘levered’ beta, that is the beta accounts for the capital structure of each individual company. More specifically, the beta accounts for the structure of company liabilities which are comprised of debt and equity elements and the risk associated with each element. As each company is likely to have very different capital structures and different associated risk, we must first ‘unlever’ each company’s beta in order to eliminate the effect of differing capital structures from each comparable beta. To unlever beta, we must divide each levered beta, (BL), by [1 + (1-Tax Rate) x Debt Value/Market Equity Value], for example:Unlevered Beta (Bu) = BL / [1 + (1-T) x D/E]Equation 4.4Once we established Bu for each comparable company, we took the average unlevered beta for the industry group, including Starbucks’ Bu, and introduced this average Bu (0.6265) in the following rearrangement of Equation 4.4 to estimate Starbucks’ re-levered beta. In doing so, we using Starbucks own debt-to-equity ratio (D/E).Levered Beta (BLSBUX) = Bu [1 + (1-T) x D/ESBUX]Equation 4.5Exhibit I highlights this process of unlevering and re-levering Starbucks beta. The process returned a re-levered beta of 0.6747 which, whilst not the lowest in our range of beta estimates, was at the lower end of our set of estimates. As can be seen in Exhibit D, Starbucks has the lowest debt-to-equity ratio of the comparable set, being 11% versus an average almost 44% for the five comparable companies. As such, we can see that stripping out the effect of capital structure created a far more dramatic reduction in Bu versus BL, on average, for the comparable group than it did for Starbucks alone.By using this industry Bu, we are concerned the subsequent re-levered BL for Starbucks is too low an estimate. As such, we have not included the re-levered beta as a candidate for Starbucks' levered beta and instead chose the median of the former six estimates (Table 4), 0.771, as our best objective estimate of Starbucks levered beta. Risk Free Rate (Rf)The Risk-Free Rate, Rf, is a theoretical rate of return an investor would expect to obtain on a riskless investment, i.e. one which carries zero risk. We say ‘theoretical’ as no investment is considered to be entirely without risk. In practice, it is common to use the returns on US treasury bills to approximate Rf as government bonds are considered one of the safest investments, and thus the closest to risk-free. As we are interested in finding the risk-free rate associated with Starbucks, and we expect Starbucks to have a long future, we have used the 30-year US treasury bill return (with constant maturity) as our proxy for Rf. Using historic data obtained from the Federal Reserve Economic Data (FRED) website we first reviewed how this 30-year return had changed over time. As our review demonstrated minimal change over time we saw no need to adjust the most recent rate (April 2017) a of 2.87% and used this as our Rf.Market Risk Premium (Rm)The market risk premium is the difference between the expected return on a market portfolio of stocks (not solely Starbucks stock) and Rf. We studied historic annual market risk premium to gain our estimate of the future market risk premium to use in our WACC calculation. Using Ibbotson data, which provides asset class returns dating back to 1926, we calculated the market risk premium for each year (1926-2012) by subtracting the risk-free rate, using returns from long-term government bonds as a proxy for Rf, from the returns obtained from a portfolio of common stocks. From a quick review of the market risk premium calculations it is clear there is a lot of variation year-on-year. As such, we sought to find an average market premium across a period we felt would be reflective of the future. We calculated the average market risk premium across three different periods as outlined in Table 5 with supporting rationale. Table 5: Using Ibbotson’s Data to Form an Estimate of Market Risk Premium.To further guide our estimate, we reviewed recent research from credible sources (i.e. KPMG) to obtain their view regarding a satisfactory estimate of market risk premium. As the median of our three estimates, 6.29%, was relatively close to the estimates from the additional secondary sources we opted to use 6.29% as our estimate for market risk premium. As we now have defendable estimates for all components of the cost of equity we calculate Starbucks’ estimated cost of equity to be 7.72% in Table 6.Table 6 Starbucks’ cost of equityre = Rf + β*(Rm - Rf)re = 2.87% + 0.7707 * (6.29%) = 7.72%4.1.3 Capital Structure The next step towards calculation of Starbucks WACC is to understand Starbucks capital structure in order to determine the respective debt and equity weightings (Wd) and (We) required for the calculation. From our valuation of Starbucks debt above, we know the market value of debt (D). In order to establish the market value of Starbucks equity (E) we multiply the company share price ($60.87, May 11th 2017) by the total number of shares outstanding (1457.4m). Table 7 confirms the resultant market value of (E) is $88,711.94m. Using our calculation for D ($9,917.6m) we can confirm the debt and equity weightings to be ~10% and ~90% respectively, as shown in Table 7. Table 7: Calculating Starbucks Debt and Equity WeightingsWd = (D / (D + E)) = 9918/ (9,918 + 88,712) = 10.06%We = (E / (D + E)) = 88712/ (9,918 + 88,712) = 89.94%We now have all components required to calculate our estimate of Starbucks WACC. Using Equation 4.2 in conjunction with Table 8 and Starbucks effective tax rate of 32.19% we estimate Starbucks WACC to be 7.11%Table 8: Starbucks WACC Components and CalculationWACC = [rd * (1 - T) * Wd] + (re * We)WACC = [(2.49% * (1 - 32.19%)) * 10.06%] + (7.72% * 89.94%) = 7.11%4.2 Creating Free Cash Flow ProjectionsBefore we can use our WACC, we must first project the future annual FCFs for Starbucks. In doing so it is important to understand the key drivers of future FCFs, being i) sales growth, ii) operating income after tax, iii) capital expenditures, including acquisitions and operating lease investments, and finally iv) changes in working capital. Of these factors, it is arguably most critical to understand the key drivers of sales growth. This is because when applying DCF methodologies we typically review historic trends to understand how cash-flows relating to drivers ii-iv relate to either the value of sales, or the level of sales growth in a given year. As already alluded to, future sales growth (or decline) at Starbucks is primarily a function of the number of new stores opened (closed) and the growth (decline) in same store sales, being the average annual sales achieved at existing Starbucks stores. In the following section, we outline our methodology for calculating robust assumptions for the FCF relating to key drivers i-iv and conclude with a description of the final steps required to complete our DCF analysis. 4.2.1 Base Year Free Cash FlowThe latest full year financial information we have for Starbucks is for the period ending September 2016. Whilst the most recent historic performance can be a good gauge of future performance, in order to gain comfort in any future growth, cost or investment assumptions we have assessed historic trends by reviewing multiple annual periods. The purpose is not only to understand typical, “normal” performance trends but to also adjust our 2016 free cash flow to account for any break from the historic trend included in the 2016 financial results. This is because 2016 financial results shall form our base year from which we will apply growth assumptions to create financial projections. The process of adjustment is referred to as ‘normalizing’ base year (2016) free cash flow. Normalizing involves the review of historic Starbucks financial data to assess trends and make adjustments to key elements of the financial statements, Operating Profit, Net Capital Expenditure and Investment Needs, and Working Capital adjustment, and find normal rates to aid our future estimates for each of these elements before subtracting appropriate taxes due.i) Normalized Operating Profit After Tax: Normalizing operating profit involves removing the effect of non-recurring expenses and/or revenues from the operating profit whereby the resulting normalized number reflects the future operating profit a buyer of Starbucks would expect from the business in its normal line of operation. To understand the cash generated by normal operations we must subtract taxes, with the resultant financial figure known as normalized operating profit after tax (NOPAT). We assume a tax rate of 32.19%, being Starbucks’ effective tax rate in 2016. Table 9 demonstrates the adjustments made to 2016 operating profit before tax, and the subsequent NOPAT, and is followed by a description of the adjustments. Table 9: Adjustments to Starbucks Operating Profit In calculating NOPAT of 13.9%, the adjustments we made include:One-off income or expenses are typical and can occur every year, or infrequently, depending on the business and circumstances. To eliminate the impact of anomalous one-off income and/or expenses we reviewed non-operational income and expenses stated in the accounts for 2011-2016. We eliminated major extraordinary revenues or charges including, gains on sales of properties in 2011 (income), litigation credits (2012) and a unique litigation expense (2013). All residual non-operating (one-off) income and expenses were netted for each year and the average across the years of $10.18m was used as our estimation of a ‘typical’ value of one-off income/expense for Starbucks going forward. Research and development (R&D) and marketing expenses for the period. Accounting standards stipulate that R&D and marketing should be considered an operating expense, however as R&D and marketing are both designed to generate future growth the more logical approach is to treat these expense items as capital expenditure and thus adjust operating income by adding these expenses back, albeit less current year amortization of prior year marketing/R&D expenses based on an assumed three-year useful economic life of R&D/Marketing investments (Table 10).Table 10: Adding back R&D/Marketing expenses to be amortized in future periodsFinance charge associated with operating leases. These charges are added back because these expenses are considered to be financing rather than operating expenses. To calculate the lease charge, we applied our weighted average cost of debt to the present value of operating lease payments. See Table 12 (Net Capital Expenditure)ii) Net Capital Expenditure: The calculation of base year net capex / investment needs comprises two components: forecasting net capital expenditure and forecasting investment in operating leases. With regards to net capex, we first looked at Starbucks historic capital expenditure associated cash flows and expenses. Cash outflows included all gross capital expenditure in a financial period plus cash used for acquisition purposes. From these cash outflows we subtracted capital expenditure depreciation expense for the period (as this is a non-cash expense subtracted before arriving at operating income). We looked at the cash flow and expense values associated with each of the three dimensions of capex as a percentage of annual sales for each year 2011-2015 and calculated an annual average over the period. We used the averages for the three dimensions to calculate an implied normalized value for 2016 capex, acquisitions and depreciation for our base year net capital expenditure value (Table 11). Our estimate for 2016 normalized capex is $662.60m.Table 11: Using Historic Averages to Calculate Estimate for 2016 Normalized Capex Investment*Net Capex = Capex - Depreciation + AcquisitionsTo calculate our base year investment in operating leases, our first step was to calculate the annual investment in new leases for each year between 2011 and 2016. This process required us to calculate the present value of lease commitments for each year between 2011 and 2016 (or this process we assumed the same cost of debt as outlined in our WACC calculation). The annual investment in new leases was determined by the change in the present value of leases each year. We next calculated each annual investment in new leases as a percentage of annual revenues and took an average percentage across the 2012-15. As shown in Table 12 this average percentage of ~2.1% was applied to 2016 revenues to provide our estimate of our baseline normalized 2016 investment in new leases, $447.56m. Table 12: Calculating Normalized Investment in Operating Leases as Percentage of Annual Revenueiii) Net Working Capital: As a company grows it needs to invest in inventory (materials and other inputs) to ensure they have sufficient product to serve their higher customer base. Additionally, with increased sales it is reasonable to assume that the proportion of non-cash, credit sales (accounts receivable) will be maintained, and thus the dollar value increase (decrease) in line with sales growth (decline). Similarly, it is reasonable to expect that the proportion of credit purchases (accounts payable) will also be maintained, and the subsequent value of accounts payable to increase in proportion with sales growth. Net working capital investment refers to the sum of investment in inventory and accounts receivable (working capital assets) less accounts receivable. To estimate our base year net working capital requirement, we calculated net working capital for each year 2011-2016 and for each year 2011-2016 we calculated the annual net working capital growth as a percentage of the annual sales growth. The average ratio across the 5 years was then calculated as 5.1% and applied to Starbucks 2016 actual sales growth in order to determine base year net working capital investment cash flow. We calculated the average excluding the 2012 ratio of 33% as this appeared anomalous (Table 13) versus the other ratios calculated. As a positive number, ~$108m, this figure implies that as Starbucks’ sales grow they invest more in, and have a net cash outflow related to their net working capital.Table 13: Calculating Normalized Investment in Net Working Capital (NWC) as Percentage of Change in Annual Revenues4.2.2 Future Free Cash Flow (FFCF) Projections FFCF – Revenue: As previously discussed, Starbucks future sales growth assumptions not only drive sales in future years but are also directly related to future cash flows relating to NOPAT, capital expenditures and working capital investment. As such, it was critical we considered multiple data sources to ensure realistic forecast assumptions for our DCF analysis. To begin, we reviewed historic 10K’s to retrieve company data spanning 2011-2016 and assessed the growth trajectory in overall dollar sales, same store sales (SSS) growth and Starbucks’ new store openings for each of the three key regions Starbucks operated within; The Americas, Asia Pacific (APAC) and Europe, Middle East and Africa (EMEA). We were also able to separate our data by the type of store, be it company owned or licensed. This is particularly important because depending on the nature of store ownership, different levels of revenue are attributable to Starbucks. We used the historic data to: 1) Calculate an implied dollar SSS value to use as a base from which to apply future same store sales growth assumptions, and;2) Verify that forecast store growth, obtained from a review of analyst forecasts, appeared appropriate, and not too low nor disproportionately high.As an example, Table 14 demonstrates the historic data we collected for company owned stores in the Americas region. We collected similar data for company owned stores and licensed stores within each region. Table 14: Americas Region Company Owned Store Historic Data to Aid Revenue Analysis and ProjectionOur future SSS growth and new store growth assumptions were based on the average forecast derived for each these metrics based on data from a set of industry analyst reports (UBS, JP Morgan, Piper Jaffray). We made sure to include only analysts who had revised or reconfirmed their forecast assumptions after Starbucks management had released their most recent earnings call on April 27,2017. To calculate forecast revenue for 2017, for example, we took the sum of: - Number of existing stores at fiscal end 2016 x (2016 implied SSS x (1 + assumed SSS growth rate 2017)- Number of new stores opening in 2017 x (2016 SSS / 2)Our rationale for using 2016 SSS for new stores opening in 2017 rather than the same SSS value for pre-existing stores is that we expect new stores to take time to get up to the level of sales of existing, established stores. Additionally, we divided 2016 SSS revenue by 2 as we assume that new stores are, on average, open for only half of the year, i.e. some will be open throughout the year and achieve 2016 x SSS in revenue, whereas others will be opened closer to the 2017 financial year end and thus contribute closer to zero revenue in 2017. To ensure we could make as accurate revenue estimates as possible, we divided our revenue forecasting to allow a forecast for each of the major global regions in which Starbucks operates and created forecasts for both company owned and licensed stores within each region. Table 15 continues from Table 14 as an example to show how we used historic data relating to company owned stores in the Americas region alongside average analyst growth assumptions (stores growth and SSS) in order to develop short-term (2017 and 2018) revenue forecasts for company owned stores in this region.Table 15: Forecasting 2017 and 2018 Revenue Growth for Americas Region Company Owned StoresWe believed our approach to be more accurate as we note that analyst assumptions regarding Starbucks’ store growth forecasts varied considerably between each of the three regions. Furthermore, average analyst assumed rates of growth for company owned stores also differ considerable to their growth assumptions for licensed stores within a region (Table 16)Table 16: Average Analyst Growth Forecasts for Company Owned and Licensed Stores per RegionAnalyst assumed SSS growth did not have as much variability year-on-year or between regions. As such we chose to use the average across regions and years (2017-19) to drive our assumed SSS growth to drive our revenue model (Table 17)Table 17: Average Analyst Growth Forecasts for Starbucks Company Wide SSS growthTo summarize, Exhibit J identifies the key revenue growth drivers per region used to forecast our 2017 revenue. We also needed to forecast the Channel Development and Food Service division revenues at Starbucks. Collectively these divisions contribute 11% of Starbucks revenue and grew at 12% and 7% respectively in 2016, however this was lower than the 13% and 10% growth recorded in 2015. Despite the short historic period for growth comparisons, we chose to hold 2017 growth at 2016 rates (Table 18), and to also reduce 2018 growth rates by 1.25% as we feel Starbucks may have reached peak growth in 2016 for both the Channel Development and Food Service division.Table 18: Forecasting Revenues in Channel Development and Food Service Business Units Upon calculating the sum of forecast store sales, channel development and food service revenues our 2017 revenue forecast was $23,150.79m, which implies revenue growth of 8.6%. We are comfortable with this result as it falls within the management’s most recent guidance of 8-10% sales growth for 2017 (Table 19). For 2018 revenue, we followed a similar approach to 2017, however our overall revenue growth in the period was 9.6%.Table 19: Starbucks Revenue Forecast 2017-18: Our Estimate Versus Management GuidanceThe key reasons for this increased growth in 2018 is the continued growth in new store openings and SSS coupled with the expectation that new stores opened in 2017 will contribute a full year revenue and do so at a level in-line with established Starbucks stores. Rather than accept this 9.6% rate, for the reasons outlined below we have tempered back the 2018 sales growth rate generated by our revenue model:Most recent quarterly results show Starbucks’ comparable same store sales growth of only 3% versus 3.6% forecast. Starbucks delivered $5.29B revenue, being ~ $120m lower than analyst expectations. Whilst analysts have reaffirmed or amended their 2017 expectations following these results, and we have used this guidance for our estimation, as 3% is the lowest same store sales growth since 2009 we hold concern that anticipated 3.9% growth in 2018 may be too optimistic.Asia Pacific (APAC) is quoted by Starbucks management as a major growth engine for Starbucks in short-medium term. Key economies within this region, India and China, have recently posted lower than forecast GDP (India) or has GDP growth forecasts lowered (China). Credit rating agency, Moody’s, also recently cut the Chinese economy rating due to the surging level of Chinese debt, which now stands at ~250% of GDP. Such information has also made us question further growth in 2018 and influenced our decision to temper the 2018 growth rate. When valuing a company, a key assumption made is that we are valuing the FFCF out to eternity. That is, we expect the company has an infinite life and will continue growing and producing cash-flows for an infinite amount of time. Our 2017 growth rate of 8.52% is much higher than the historic or forecast US GDP, and we cannot assume Starbucks can continue to grow at this rate forever as to do so would assume Starbucks effectively becomes the US economy! As such, at some point in our forecast DCF model we have to assume that Starbucks will grow in-line with the economy and continue to do so. We have chosen a DCF forecast period for the years 2017-2022. We therefore assume that following 2022, Starbucks revenue growth will fall in-line with economic growth. We therefore assume that over the period 2017-22 the revenue growth rate reduces at a constant rate (Table 20) until aligning with our 3.9% forecast for economic growth in year 2022 (see Terminal Growth). Table 20: Revenue Growth Trajectory 2017 to 2022 and beyondBy 2022, the America’s region is forecast to contribute 78.45% pf Starbucks revenue, APAC 15.58%, and EMEA 5.96%. As we have established our revenue projections, we can progress to calculate our projected NOPAT, capital expenditures and net working capital investments to allow us to calculate FFCF projections.Projected Net Operating Income After Tax (NOPAT):Using our 2016 base year calculations, we calculated the base year NOPAT as a percentage of 2016 revenues. We continued to use this 13.9% to calculate NOPAT for each year in the DCF forecast period (Table 21). For example, 2017 NOPAT of ~$3.2B is calculated as 13.9% of $23B, being our 2017 forecast revenue. Table 21: Operating Profit Forecast 2017 - 2022Projected Net Capital Expenditure (capex) / Investment Needs:Having used historic financial data to estimate the dollar value of all components included in base year 2016 capex/investment needs, we took the sum of these baseline 2016 capex related cash flows and calculated capex/investment need cash flows as a percentage of 2016 sales to be 5%. We used this ratio of 5% and tapered down to 0% by 2022 (Table 22). Our rationale for doing so stems from our previous discussion about Starbucks growing in-line with the economy from 2022 onwards. As such, growth in sales from 2022 onwards is not assumed attributable to growth in stores, and thus we assume net capex to be zero, and any capital expenditure to be cancelled out by a corresponding depreciation charge. Table 22: Net Capital Expenditure (incl. Investment in Operating Leases) Forecast 2017 - 2022Projected Changes in Net Working Capital:Once we established the 5.1% average growth in net working capital as a percentage of annual sales growth we decided to hold this percentage constant throughout the forecast period (Table 23). For example, 5.1% of the dollar value of Starbucks sales growth each year is assumed to be equivalent to our forecast net working capital investment required to meet such sales growth.Table 23: Net Working Capital (NWC) Investment Forecast 2017 - 20224.3 DCF Valuation Exhibit K is our DCF model and illustrates how we have used, and built from 2016 base year estimates in order to forecast all relevant cash flows contributing to our projection of Starbucks annual FCF for the period 2017-2022. As previously noted, we assume that after a period of time Starbucks will generate FCF at a steady state forever. We assume this occurs post 2022. Whilst the annual FCF up to 2022 all differ, our assumptions dictate that from 2022 onwards annual FCFs are identical. We refer to the value of all FCF beyond the projected period (2017-2022) as the Terminal Value (TV), and we use a perpetuity growth method to calculate the TV as follows: TV = FCF2022 (1 + g) / (WACC –g)where the variable ‘g’ is the growth rate we anticipate FCF to grow each year from 2022 to perpetuity. As noted earlier, whilst Starbucks growth may presently be higher than that of its competitors, and that this growth rate is greater than forecast global GDP growth (2.7%), we cannot expect the growth rate of Starbucks FCF to outpace global GDP growth into perpetuity. As such, we reviewed forecast nominal GDP growth rates for the key countries (markets) that Starbucks operates in, being the countries that contribute the most to each of The Americas, APAC and EMEA region revenues. Our goal is to use a weighted average of forecast GDP growth rates in these key markets as our approximate for ‘g’. For each region we calculated the average GDP growth rate expected for each key market for each year 2015-2022 using data from the International Monetary Fund, World Economic Outlook Database, April 2017. We next calculated a weighted average growth rate for each year by weighting average regional growth rates using each region’s forecast proportion of total Starbucks revenue as the region weight. The average growth rate calculated across the 2015-2022 period was ~3.92%, which we selected as our approximate of our perpetuity growth rate, g. Exhibit L demonstrates our approach to constructing our estimate of g. The TV calculated reflects a value as of 2022. As with all future FCF calculated for years 2017-2022, we must discount back to present value using our WACC estimate of 7.11%. The sum of the annual discounted FFCFs, including that of the TV, provides our DCF estimate of the enterprise value (EV) of Starbucks: $105,179m (~$105B). We shall proceed to compare this estimate of EV to a set of implied EVs obtained using comparable company analysis within our Relative Valuation techniques.5 Valuation Technique: Relative Valuation5.1 Choice of ComparablesAs we have researched Starbucks it has become evident that finding direct comparable companies to Starbucks is difficult. A comparable set used by one analyst can be very different to that used by another. A company may offer similar menu items, but only operate a handful of stores and have limited international exposure. As such, the use of comparable companies to aid our valuation of Starbucks is not as straightforward as we’d like. Nevertheless, we have applied a method to narrow down a set of comparable companies with a view to using the valuation metrics relating to the comparable set (i.e. company value as a multiple of company revenue) to assist our assessment of Starbucks value. To begin we created a master list of all the companies that share the same SIC code as Starbucks. After reviewing the list of ~68 companies we eliminated 2 companies; Aramark and Sodexo. These companies provide services to restaurants and manage facilities, however they are not food and beverage retailers and thus we do not consider a close comparable to Starbucks. We next using three criteria: The first step was to remove all companies that were not comparable to Starbucks size in terms of annual revenues. The limitation of this ‘size’ criteria is that Starbucks generates over $20B revenues per annum, whereas the majority on the list generated less than one tenth of that. We chose to eliminate any company that did not generate more than $1bn in revenue. This seems a natural cut-off as any higher would have limited the comparable set and there was also a clear division whereby companies either generated more than $1B or they generated much less than $1B. Of the remaining 24 companies, we reviewed their operating margin (EBIT used as a proxy). We chose to filter out companies with EBIT margins that were greater than +/- 9% of Starbucks’ EBIT of 18.08%. This gave us a range of 9.08% EBIT margin up to 27.08%.The final 8 companies were assessed based on their projected 5-year growth rate. The five companies with a projected growth rate closest to Starbucks’ projected growth rate of 15.33% were selected. As a result of our filtering approach the five remaining companies were: Wendy’s Corp., Jack in the Box, Domino’s Pizza, Panera Bread and Yum Brands Inc.ii. Valuation MetricsFollowing our selection of comparable companies, we looked at 3 different yet common valuation metrics: Multiples for Enterprise Value divided by i) Revenue, ii) EBIT and iii) EBITDA.Enterprise Value (EV) is a more comprehensive measure of the market value of a company and accounts for claims by all claimants on the company, i.e. debt holders and equity holders. As such, EV is a more accurate measure of the theoretical price to acquire a company debt free. EV is calculated by taking the company’s market value of equity (shares outstanding * share price) + Debt – Cash.Revenue, EBIT and EBITDA values reflect the latest twelve months (LTM) performance. As such, these values may not be found using only the most recent 10K. Table 24 outlines each valuation metric calculated for each comparable company and identifies the median value for each metric. We highlight the median value as this statistic helps to eliminate the effects of any outliers within the set that may distort a simple average. Table 24: Valuation Metrics Calculated for Comparable Group5.2 AdjustmentsOnce we had the 3 median valuation metrics, we compared the median expected growth rate, EBIT margin and revenue for the comparable company set to Starbucks own projected growth rate, EBIT margin and LTM revenue. Where there was a notable difference between Starbucks’ metrics and the comparable company median we suggested an appropriate adjustment, limiting ourselves to adjusting between -10% and +10%. The reason for making the adjustments were to get the closest representation of a direct comparable to Starbucks. As Starbucks’ expected growth rate was close to the 16.2% median, we felt no adjustment was required. We applied a +3% adjustment to EBIT Margin given Starbucks margin was ~33% greater than the comparable median. Finally, with almost $22B revenue Starbucks’ size is clearly larger than that of the comparable median and thus, in our opinion, warranted a full +10% adjustment (Table 25). Table 25: Adjustment Required for Median Valuation MultiplesThis sum of our adjustments was +13% and confirms our belief that each of the three median valuation multiples should be increased by 13% to account for key Starbucks company attributes (i.e. size) and growth expectations (Table 26). In other words, we believe there are positive factors specific to Starbucks which warrant a premium of ~13% to the valuation of the comparable company set. We multipled each valuation multiple by 1 + 13% (1.13)Table 26: Applying Adjustment and Re-calculating Valuation Metrics for Starbucks To obtain the implied EV for Starbucks for each valuation multiple we simply multiply each multiple by the relevant Starbucks financial figure for the last twelve months, as is shown in Table 27.Table 27. Implied Starbucks Enterprise Value Using Adjusted Valuation Metrics6. Summary of ValuationThrough application of DCF and Relative Valuation techniques we have four estimates for Starbucks Enterprise Value (Table 28). It is pleasing to note that, whilst each EV is different, the range of EV values is relatively small which gives us comfort in our growth assumptions. Table 27: Estimated Enterprise Values Using DCF and Relative Valuation TechniquesTo complete our analysis we sought to demonstrate the equity value per share (market share price) implied by each of the four EV estimates. As previously discussed, EV = Equity Value + Debt - Cash. To obtain Starbucks equity value we must, therefore, add back cash and subtract debt from each EV. Once we have established the implied equity value we divide this value by the total number of Starbucks shares outstanding (1,457.4m) to obtain the implied equity value per share. Exhibit M shows each step in this process, and in Table 29 we confirm each of our four equity value per share estimates.Table 29: Implied Equity Value per Share Using DCF and Relative Valuation TechniquesThe actual Starbucks share price as of 11th May 2017 was $60.87. As we can see from Table 14, the range of valuation estimates are all higher than the present Starbucks share price. We also compare our estimates to the 12-month target (forecast) share price of a selection of industry investment analysts (Exhibit N). The average target for the analyst set is $64 (median $65), which is not far from our average ($68.23) and median ($68.24) equity value per share estimates. Whilst close, our estimates are still higher than the existing share price and analyst consensus. We recognize any estimate is based on our best efforts to forecast the unknown and that our estimate of Starbucks value will differ, perhaps considerably, from other estimates due to variations in key assumptions driving future FCF. From our analysis, we note that the estimation of the WACC and terminal growth rate (g) as well as adjustments made to relative valuation metrics can have a major influence on the overall EV estimate. Exhibit O, for example, shows how even a small adjustment to the terminal growth rate (g) and/or WACC has a significant impact on the EV and subsequent equity value per share estimates obtained from the DCF model. In our assessment of Starbucks, we feel that we have placed solid efforts to make robust, defendable assumptions to drive our valuation estimates. Whether our 2018 revenue growth prove too conservative or our estimate of ‘g’ too high, for now these estimates appear as good as any other.AppendixExhibit A - Interest Coverage TableThe table below created using data from Compustat. The following steps were taken to generate the data: All EBIT and interest expense for all companies was exported from Compustat. Companies in the financial industry (SIC starting with 6) and industrial companies (SIC starting with 49) were eliminated from the dataset. The ratio of EBIT/INTEREST was calculated along with the statistics shown.Exhibit B - Altmans-Z TableExhibit C - Average Bond Spread The treasury yield for each maturity was culled from the Saint Louis Federal Reserve Economic Data (FRED) (). Treasury yields are only available for the seven maturities shown. The bond yields are the average yield based on S&P bond ratings data from Bloomberg. Exhibit D - Starbucks Long-term Debt Schedule (Source: Starbucks 2016 10K)Components of long-term debt including the associated interest rates and related fair values by calendar maturity (in millions, except interest rates):Exhibit E - Present Value of Starbucks Debt, Starbucks Debt Repayment Profile (incl. operating leases) Exhibit F - Daily Regression Output - Starbucks Returns and S&P 500 Index ReturnsExhibit G - 5-year Monthly Daily Regression Output - Starbucks Returns and S&P 500 Index Returns Exhibit H - 2-year Monthly Daily Regression Output - Starbucks Returns and S&P 500 Index ReturnsExhibit I - Unlevering and Re-levering Starbucks Beta Exhibit J - Key 2017 Revenue Growth Drivers per Region Exhibit K - DCF Model and Driving AssumptionsExhibit L - Perpetuity Growth Rate Calculation Using Forecast GDPExhibit M - Calculating Equity Value per Share Using Each Estimate of EVExhibit N - Industry Analyst Starbucks Target Share Price Exhibit O - Sensitivity Analysis: Change in EV & Equity Value per Share driven by changes in WACC and/or ‘g’ ................
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