SBUX: Markets Miss the Value in a $5 Frappuccino

NEW YORK (TheStreet) -- Some of history's most important agreements - major and minor, involving real disputes and amiable "win-win" situations -- have come over a simple cup of coffee. Just imagine the wars averted, the marriages that have been proposed over a $5 beverage.

So, evaluating the phenomenon that has become Starbucks ( SBUX), it seems appropriate that I measure the company on its social effects, in addition to its impact on the market.

I have no shame in admitting I am a huge indulger of coffee from Starbucks -- particularly its Caramel Frappuccino. It is bold but yet very easy to drink. Not only does the caramel lend a distinct buttery sweetness, but the fluffy swirl of whipped cream adds just the right touch of decadence. But I digress...

The concern on the minds of investors these days suggests that not only is the company's coffee expensive, but so is its stock price. Normally, I would agree by virtue of its price-to-earnings ratio of 36. That is almost double McDonald's ( MCD) P/E, but noticeably less that Dunkin's ( DNKN).

But given the company's earnings results on Thursday, it is evident that, for Starbucks, not only are these valuation metrics inconsequential, but the stock may yet be cheaper than investors realize and just might deserve " Chipotle-esque" ( CMG) consideration.

What Do I Get for $5?

Well for starters, how about an 18% jolt in the company's fiscal second quarter. Global revenue increased 7% at locations that have been opened for at least one year.

This figure suggests the company is benefiting not only from an increase in foot traffic, but customers are also paying more per visit. The figure is a key metric because it excludes the impact of newly opened or closed stores.

The Chipotle comparison comes into play here because as Chipotle trades at a multiple 20 points higher than Starbucks, its growth expectations are highly attributable to performances similar to those Starbucks just reported.

Consider that Chipotle's popularity and stock has grown commensurate to strong customer traffic as well as stronger sales volumes. As a result, on the release of its IPO in 2006, the stock doubled on its first day of trading from $22 to $44. On Thursday is closed at $414.

To support the growing demand, Chipotle has gone through an aggressive expansion plan to where it now has 1,230 restaurants, adding 150 new locations in 2011. It does not plan to stop there, but will open between 155 to 165 new restaurants in 2012. Not only does the company receive tremendous support from investors, it is clear that by its recent string of earnings beats the company continues to benefit from a strong loyal customer base that loves their burritos.

So if astute investors can substitute lattes for burritos and apply an extra 20-point multiple to Starbucks, they'll have a stock that is undervalued by at least $15 dollars.

In essence, for a $5 cup of coffee, investors get a $15 premium on a stock that can only grow from current levels -- one that just earned $309.9 million or 40 cents per share where analysts on average had expected a profit of 39 cents per share on revenue of $3.18 billion, according to FactSet.

Moving Forward

As great as these numbers were, the company does not plan to rest on its laurels and intends to stay caffeinated. Management said it is heavily investing in international expansion while also raising its forecast for the year.

A significant portion of its gains came from China as well as the Asia Pacific region. The company considers that region to be one of its most critical in terms of expansion, even suggesting that, by 2014, China will become its second-largest market behind the U.S.

Also, as a sign of just how much it plans to maintain its leverage and grow its margins, the company has started to look beyond its cafes by announcing plans to open its first Evolution Fresh Inc. juice store.

For the full year, Starbucks now expects earnings per share to be in the range of $1.81 and $1.84. Analysts were expecting earnings of $1.86 per share. At present, the company has more than 17,000 cafes around the world and recently said it will accelerate new store growth this year to approximately 1,000 net new stores globally.

Similar to Chipotle, it is clear that Starbucks expects to grow into any valuation permitted by heavily expanding customer traffic. So why is it not presently trading in line with Chipotle?

Bottom Line

For $5, I'm able to get out of the house for a couple of hours to relax and enjoy a Caramel Frappuccino as I write this article. In the process I am able to enjoy some soft music and a slice of Banana Nut Loaf -- all of which are cheaper alternatives to many other leisure activities out there.

Though it seems that the market may continue to apply a relative discount to Starbucks, both value and growth investors should look to jump on its shares at any signs of weakness. Even on the most conservative assumptions, the stock will be at $70 by year's end.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

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