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Why We're Not Adding Starbucks Into The Portfolio
You’d be able to recognize their logo anywhere around the world.
Visual Capitalist ranked Starbucks the 29th most valuable brand in the world in 2021.
Ahead of companies/brands like Disney, YouTube, TikTok, and Walmart.
Starbucks has 34,600 stores across 84 countries.
Their Starbucks loyalty program was a pioneer in the food & beverage category. Most mobile apps with membership programs were likely inspired by the success of Starbucks.
A study from The Manifest shows that “nearly 48% of mobile users who often use restaurant loyalty apps use Starbucks Rewards.” FoodNews stated, “As of October 2020, the Starbucks Rewards program has over 19.3 million members and generates nearly 50% of their revenue.”
In the early days, Starbucks’ mobile app was processing more volume than Apple Pay.
Here’s what we said about Starbucks last week in our missive Which Companies Will Make It Through:
“Meanwhile, Starbucks has the global supply chain established. They have that $4 billion in cash on the balance sheet. Another $23 billion in property, plant, and equipment (PPE). And $1.8 billion in customer deposits on their mobile app.
(Customers who deposit money onto the Starbucks app go onto the liabilities side of the balance sheet. This is effectively free money as customers give Starbucks money upfront… which gives them the ability to spend it on anything in exchange for a cup of coffee, food item, merchandise, etc. at a later date.)”
Today, Starbucks is around 40% off its all-time highs.
Starbucks has a rock solid balance sheet. Their cash flows are still strong despite inflation everywhere — including coffee prices at 10-year highs. They’ve grown their dividend at a 10% compound annual growth rate over the past five years. And a 2.6% annual dividend yield.
Getting paid 2.6% on one of the most recognizable (and extremely valuable) brands in the world that’s 40% off its highs… What’s not to like?
Starbucks fits perfectly within our Trophy Asset Pillar:
Globally recognized brand
Strong balance sheet
Growing dividends by 10%+ annually
A company we know is likely going to be around 50 years from now
We have the chance to pick Starbucks up at a 40% discount to its all-time highs.
So why aren’t we adding them to our portfolio?
Because of two major risks we cannot control/predict: Both have to do with China.
The first, obvious risk is geopolitical.
First, the U.S. and Europe sanctioned Russia and pretty much removed them from the financial system.
Then, the number of companies who immediately withdrew and/or suspended operations in Russia due to the war was unparalleled. Not just the fact that they stopped operations. But the swiftness of their actions. And the amount of money they left on the table.
Oil companies withdrew and wrote down their assets to $0 in the blink of an eye. BP wrote down their 20% stake in Russian oil producer Rosneft to $0 — what amounted to $14 billion — just like that.
All companies. Shell, Apple, McDonald’s, everyone. They ceased their operations overnight. Starbucks too.
But it’s not Russia that gives us pause for Starbucks. It’s China.
China makes up 31% of Starbucks’ total owned and operated stores.
Not just that, but China accounted for 125% of all Starbucks’ net new store (stores opened - stores closed) growth.
You can see Starbucks opened 654 stores in China. And just 25 in the U.S.
China is Starbucks’ growth engine.
At one point in 2019, they were adding a Starbucks store in China every 15 hours.
Former CEO Kevin Johnson said in this 2019 Bloomberg interview:
“We can do that [build stores in China every 15 hours] for decades to come…
We are going to build Starbucks into 100 new cities in China that we are not currently in. And every one of those cities is larger than the population of Los Angeles. So we will be building stores in China for decades to come.”
China accounted for 10% of sales in 2019. And 12% of sales in 2021. China makes up 16-17% of Starbucks’ operating income.
However… the Chinese government has been known to change its mind on whether they accept outside companies to operate in the country.
There’s no Google. Facebook. Twitter.
It also forces companies to abide by its rules — whatever they are — at all times.
Relent and you’re kicked out.
What is Starbucks worth if China decides to favor its own coffee shops? What happens if Starbucks takes a stance on social issues (LGBTQ+ rights, human rights, etc.) or geopolitical issues?
Howard Schultz, the interim chief executive of Starbucks, said the company has “virtually no ability to predict our performance in China.”
So what happens if China invades Taiwan… and forces the U.S. and Europe to put the same level of sanctions on China as they did Russia? Pretty much forcing most company’s hand at leaving the country to stand for human rights?
Starbucks goes from growth mode to contraction mode.
What is Starbucks worth then?
It’s not that Starbucks has no value. It’s that its cash flows could get cut significantly… and therefore wouldn’t be worth as much.
Starbucks knows this and is legally bound to list it as a significant risk in its annual filing (10K) (emphasis added):
The International segment is a significant profit center driving our global returns, along with our North America segment.
In particular, our China MBU contributes meaningfully to both consolidated and International net revenues and operating income. China is currently our fastest growing market, our second largest market overall and 100% company-owned. Due to the significance of our China market for our profit and growth, we are exposed to risks in China, including the risks mentioned elsewhere and the following:
• the effects of current U.S.-China relations, including rounds of tariff increases and retaliations and increasing restrictive regulations, potential boycotts and increasing anti-Americanism;
• escalating U.S.-China tension and increasing political sensitivities in China;
• the effects of the COVID-19 pandemic and related governmental regulations and restrictions on our operations in China;
• entry of new competitors to the specialty coffee market in China;
• changes in economic conditions in China and potential negative effects to the growth of its middle class, wages, labor, inflation, discretionary spending and real estate and supply chain costs;
• ongoing government regulatory reform, including relating to public health, food safety, tariffs and tax, sustainability and responses to climate change, which result in regulatory uncertainty as well as potential significant increases in compliance costs; and
• food-safety related matters, including compliance with food-safety regulations and ability to ensure product quality and safety.”
We’re no geopolitical experts. But the U.S. China relations are on thin ice. It’s one of the few bipartisan issues in this country.
So the probability of something going wrong that could end up affecting Starbucks isn’t zero.
That is why if we were to add Starbucks to our portfolio — in the Trophy Asset Pillar — we’d need a very big margin of safety.
We’re just not comfortable with that risk today.
Starbucks is one of the best, most recognizable companies in the world.
We’d love to have it in our portfolio one day. It’ll be a great day when we do.
But that time hasn’t come yet.
Good investing,
Lance