With New Leadership, is Starbucks a Solid Dividend Candidate?

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When a company’s stock price has struggled for years, a change in management may be just what it needs to get back on track. Even still, new management can’t fix everything.  

Historically, Starbucks has been an impressive growth story, generating phenomenal wealth for investors. Despite its profitability and strong cash flows, recent challenges have raised questions about whether those days are long gone. In this episode, Greg analyzes the Starbucks story as a potential dividend growth candidate and what the future may hold. He discusses the implications of Starbucks' new CEO (who previously turned around Chipotle), and the company's strategy to address operational inefficiencies. 

Later, Greg transitions to an update on Chevron which has been part of the model portfolio since 2010. Although higher dividend yields can signal problems for a company, Chevron’s resilience makes it worth considering adding to the position. 

00:00 Introduction to Dividend Mailbox
00:47 Starbucks: A Familiar Name with a Compelling Story
03:33 Starbucks' Financial Performance and Challenges
05:22 Evaluating Starbucks as a Dividend Growth Investment
11:33 Starbucks' Debt and Cash Flow Analysis
27:10 Conclusion on Starbucks and Transition to Chevron
28:04 Chevron: A Reliable Dividend Growth Story
29:41 Chevron's Financial Health and Future Prospects
35:41 Final Thoughts and Wrap-Up

Notes & Resources:

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Transcript

[00:00:00] Greg Denewiler: 

This is Greg Denewiler, and you are listening to another episode of the Dividend Mailbox, a monthly podcast about dividend growth. Our goal is to stuff your mailbox full of dividend checks. When they grow over time, a funny thing happens, you create wealth.

Welcome to episode 39 of the Dividend Mailbox. Today, we're going to look at Starbucks. It's a name that everybody is familiar with, whether you know the investment story behind it or not. If you're in a city of any size, you've seen them on every street corner. And even if you drive across Western Kansas, there's a Starbucks out in the middle of nowhere. It's been an extremely successful story and it's got a dividend that's grown. That has led us to look at Starbucks to see if that's going to fit. And then we'll look at a situation that we're adding money to currently. It's an old name, but we're going to give you a quick update on an idea that we followed for quite a while.

If you've been in the market, Starbucks is one of those names that's been around and in the past, t's been an extremely successful investment. Virtually everybody has heard about it, unless you live up in a forest in Montana, and they probably even have them up there. And if you go back and look at the stock historically, in 1992, if you would have put $10,000 into Starbucks, you now have $3.5 million. It has been a huge winner. And not only that, but when you compare it to the S&P 500, that same $10,000, on a total return basis, would only have grown to $254,000. Of course, that's still a big number, but it's not anywhere close to $3.5 million. 

It's got roughly a hundred billion dollar market cap. It's not small, but there's a lot of businesses that are bigger. It's not technology. So why does Starbucks get a fairly large following? Well, there's a couple pieces to it. Howard Schultz is well known, he's written a book. You've got a guy that took one coffee shop in Seattle and grew it into a global brand. And then to even make it a little more fascinating, he left the company, it floundered a little bit, and then he came back, basically turned it around. He left again and then came back in for a third time. It's got some good drama in it and if you take this story back more than 20 years, the wealth that was created in Starbucks is really pretty phenomenal. It has far exceeded what the S&P 500 has done. But now here we are again, Starbucks has some challenges. 

In the last five years, the stock is only up about 15%, including the dividends, so it's really barely up while the S&P 500 has doubled. In the last few months, the stock had a low of $75. It had an all-time high in 2021 of $126. The stock right now is trading around $92. The stock bumped about 18% a few weeks ago when the new CEO was announced. There was a lot of anticipation that here's a guy that if anybody can turn it around, he's going to do it.They've brought in Mr. Fixit. 

But they're not in big trouble yet. They still have great profit margins. They have great cash flow. It's just that when you have an extremely successful company and the stock has run into some challenges, everybody wants to play the turnaround. It really becomes a great story as far as— if there's a new vision that comes out and they get back on track, then we're off to the races again—because just catching up with market returns leaves a lot of room on the upside for this one. So that kind of opens the door; is there a chance to buy this thing relatively cheap? Lo and behold, we're dividend investors, and Starbucks pays a dividend. Right now, it's about 2.5%. It's kind of right in the middle of where we like to look, especially if we can get some growth. 

So let's just look at some numbers and see whether this thing is going to fit and work as a dividend growth story for us. 20 years ago, the stock didn't pay a dividend and earnings were 11 cents. 10 years ago, earnings had grown all the way to $1.35 and they had started to pay a dividend which was 52 cents. Over the five year period from 2014 to 2019, earnings more than doubled and the dividend went up by almost 150% up to $1.44. And just in the last five years, the dividend has grown by 47% and earnings have gone from $2.90 to $3.58.

One of the first boxes that we have to check is— this thing has been a growth story and that's what you need to grow a dividend. Starbucks historically has easily surpassed our 7% hurdle rate and in the last 10 years, it's actually grown at about 13.5% a year. So, even a dramatic slowdown in their growth rate still potentially delivers what we're looking for.

But now we're going to try to figure out if Starbucks can give us at least a double in the dividend in the next 10 years. One of the things that happened in the last five years is, yeah, they had decent revenue growth. Revenue grew from $26 billion to $36 billion.  As I mentioned, earnings in the last five years went from $2.92 to $3.58. Earnings were up 22%, but the dividend was at 47%. Well, the dividend recently has grown faster than earnings. The simple explanation for that is the payout ratio. So, the amount of money they pay out, their profits paid out in dividends, has gone from 50% to 60%. 10 years ago, it was 38%. The first thing that we have to start to look at is, okay, they've been paying out more money, which has given some great dividend performance, but that long-term is not sustainable because they're just not going to pay out 100% of their earnings. If they can just continue to grow the business at 7%a year, which is roughly what they've done in the last decade on a revenue basis, they can still grow the dividend at 7% because the dividend growth, although it's been much better historically, most of that was driven by the fact that they were paying out more of the earnings. Even if they stop upping the payout ratio and just continue to pay out the same amount of earnings, they just continue the 7% revenue growth, then there we are, we've hit our hurdle. 

Well, continuing to go a little deeper here, another thing that when you initially look at Starbucks that is extremely attractive, is this company is profitable even though they run into some challenges. Right now, the profit margin is running at around 12%, just down a percent from the last five years, but up from the historical numbers that were below that. If you look at gross profit margins, they are within a percentage or two of their highs. And they still have 18% return on invested capital. If you've listened to us in the past, you know that that's a number we put some weight on. It actually has improved a little bit in the last few years. They were in the mid-teens, now they're in the high teens. A decade ago, they were in the 20% area, the mid-twenties, so it's come down a little bit, but it's still a very profitable company. And another important thing is their incremental return on capital— which just simply is, they've grown assets, revenue has grown, so what kind of returns have they had on that growth? That number long term is 23%. So, they have been able to successfully grow the company at similar rates of return. That's an important measure to look at.

So, the underlying business is strong. There's no real problem there. But if you look at the bigger story, then you've got a company that in the last seven years has been through four CEOs. From a standpoint of the board and the company trying to stay on top of this, you got to give them credit because they haven't waited until there's real decay in the business. The business is still okay. There's just cracks in the foundation and they're trying to address them. What you've had, and the reason why you've had a new CEO come in, from June of ‘23 to June of ‘24, revenue is basically flat. They had another flat period from September ‘21 to June of 2022, where revenue was 8 billion. They've had some growth and then they've had some challenges.

Part of what makes it at least worth looking at is, okay, they got a new CEO that just came in here in the last few weeks, and he's the guy that ran Chipotle. He basically turned Chipotle around and turned it into another huge winner again. So, it's not very hard to sit here and speculate and say, “Wow, if he just has half the success in Starbucks, this thing's off to the races again.”

So next we're going to go to financially, where does Starbucks stand? This is where things start to get a little bit more interesting because number one,  Starbucks has gone from in 2018, they had not quite $1.2 billion in shareholders equity. As of September of last year, shareholder equity has dropped all the way to a negative $8 billion. Simple explanation, they have more debt than they have assets. You might right away say, “Well, that's a huge red flag, I don't want to invest in this thing.” I'm going to tell you, this is one case where I would say, I'm not going to put too much weight in that, because there's a couple things to consider about Starbucks.

About 60 percent of their revenue comes from beverage sales. Nobody is financing a cup of coffee, although we're going to get to this in a little bit, the way they raise prices, you may have to pretty soon. But anyway, people buy a $3 grande coffee or they buy one of the specialty drinks and they pay cash for it, or it goes through a credit card, or it goes on their preloaded Starbucks app.

They have days sales outstanding of 11 days, and basically what that translates into is they get paid in 11 days for their overall revenue base. But on the other side of the equation, you've got days payable. That's 21 days. They buy the coffee beans or they buy whatever products that they want to sell and they have to pay their vendors. Well, they don't pay their vendors for 21 days. What you have there, the sales are turning over faster than when they're paying vendors. They take some inventory and they've turned it into cash and made a profit on it before they even have to pay the bill for it. That right there changes the equation a little bit. They just don't need the current assets to current liabilities that a lot of companies have. Walmart's another one that's kind of famous for, they don't pay their suppliers for 60, 90 days or more, yet they demand to be paid in 30 days. So they basically get free financing. 

One of the reasons why they've gone to negative equity is they do have a lot of debt. They've got almost 16 billion of debt, but here again, I don't see this as a huge problem. When you look at their debt, of that 15. 7 billion, four and a quarter billion matures in the next three years. So then you look at risk. They've got a significant amount of money that's out more than three years locked in at low interest rates. And if you take that 4 billion and as that rolls over in the next three years, we make a simple assumption that they roll the debt over and they have to pay 2% higher interest costs (just back of the envelope). It only increases their interest costs by $85 million. This is a company that has free cash flow of over $3 billion. So, $85 million is really a nonevent there. And in some cases with the interest rates locked in longer term, you could maybe even consider that an asset. However, you have to step back and say, yeah, it's an asset if going forward, they start to put more emphasis on, we can't keep going in a negative equity situation, or we're going to risk the entire company. If they continue to put more debt on and the asset base doesn't grow much, then what ends up happening, the interest costs continue to go up and eventually they run out of free cash flow to pay debt. That would be something to watch if they start to pay off leverage or just let the revenue grow and let the debt kind of work itself out over time, then you don't have a problem.Again, back to the why don't worry about it too much right now. You almost have to give them credit too. They really managed their capital extremely well and allowing it to go negative actually improves the return on their business. 

The next thing is, so how has the cash flow gone? This is not too hard to build a picture on this. From September of 2018 to September of 2023, they paid out total dividends of $12.2 billion. We love that because we like getting those checks. If you look at total stock purchased, they bought back a lot of stock. From 9/18 to 9/23, they've bought back $24 billion. So you add those two numbers together and you've got $36 billion.Well, cash from operations over that same period was $35 billion. You got to put CapEx in there, which is remodeling stores, and building new stores. They spent almost $11 billion in CapEx. So that's where your negative cash comes in, and that's where the debt has grown from $4.5 to $15.5 billion since 2017 to 2024. All of that together reconciles and buybacks are an option. We're going to say the debt grew at the option of the board of Starbucks. They've got great cash flow and they've tried to take advantage of it buying stock back— which lowers the share count, can help earnings growth and it can help give you dividend growth. But there's a point, I mean, that is not sustainable long term.

So now we get to the heart of the matter. Is this a company that we're going to want to invest in? If you've listened to very many of these podcasts, to some degree, we live and die by this model, and that is our 10-year dividend growth. We just do a simple start the dividend today, and we're going to assume it's $2.14 and ends the year 2024 at $2.28. If they grow at 7% a year, in 2033, the dividend is going to be up to $4.20. Okay, what is it going to take to get that dividend up to $4.20? If they continue to pay out 60%, earnings have got to get to $7. Well, that's basically a double from here. Is that possible? Well, you go back and look, and you say, alright, they've put a lot of debt on the balance sheet. They've got problems with revenue right now. What's this new CEO going to come in and do? 

I'm going to be perfectly up front here. I am not an expert on the Starbucks story, but as we've looked at it, there's a couple of pretty substantial differences between Chipotle and Starbucks. They both have had a little similar track record where they were huge winners, they ran into some problems, and then they both have had some turnarounds. Chipotle is basically firing on all cylinders now. Starbucks is not. So this new CEO comes in and when he was at Chipotle, one of the things that he did is he really tried to keep the service, the speed of going through the line up. And one of the ways he did that was there aren't too many choices at Chipotle. It's burritos, tacos, a few different variations there. You go through the line, you want guacamole, what kind of hot sauce do you want? It's pretty simple, you go through the line and you're done. When you go into a Starbucks, you ask for the Hootie Fruity drink and it takes them a while to make it. There's no line process. Their speed of their line has slowed down considerably to a point where people are starting to complain about it. It's coming mostly because of the more complicated drinks, but that's also where they make more money. 

Another piece of the problem is there are so many different variations.There's food, there's retail items. He's got a real challenge of trying to figure out how he's going to streamline and get it back to where they can still get some revenue growth out of it. 

Another big problem is the prices. Chipotle is known for being a fairly value-conscious choice. You go in there and you pay $11 or $12 for a burrito. In this world, that's actually extremely competitive. You go into a Starbucks, everybody knows it's expensive. One of the strategies he may use is to cut prices to try and drive more sales, but then you have the line problem. He's got a real challenge to figure out how to fix this thing. And he's coming into an environment that's different than what he left.

And then it appears to me that a little bit of a mistake that they've made— can't think of a better way to say it. They started to think that they needed to be absolutely politically correct. And it appears that some of that has come back to haunt them. In fact, right now they're having boycotts for their stance supposedly on the Israeli Hamas war. And to be honest with you, I don't even know where Starbucks comes out on that. But the perception is that they do sort of make political statements. 

Well, since we recorded the first version of the Starbucks story, just within a few days, the new CEO came out and basically had his vision of where he thinks Starbucks is going or should go. The first major step is to make it a great place for people to go to, make it more inviting to go in and just hang out at the Starbucks. He's well aware of the line problems. He's going to try to beef up the staffing situation so that they can make the custom drinks and the lines will not be as long. His goal is to streamline the menu. It's got too many options in it and it's too complex. In his view, this is sort of along the Chipotle theory that you just don't need that many choices. 

In addition to that, also within a few days, a professor of finance out of NYU, Aswath Damodaran— we've actually brought him up in some of the past podcasts. He came out and did an overview of what he thinks of Starbucks, just looking at kind of where they are in a growth cycle, and what it's going to take them to transition. And here's a quick takeaway I just want to take on what he came up with. This is just one person's opinion, but one of the great things I like about him is he's pretty transparent and upfront. He doesn't have all the answers, but he does have a system. He's got some great ideas on how to approach valuation. Under his valuation model, if they actually go back and experience their highest, their best growth rates that they had in the past and their best margins, which actually they are currently close to right now, the stock's worth $96— which is basically where it is at the moment. Is the new CEO going to get the story really rolling again and the market's willing to pay more? He doesn’t see how they're going to do it. Part of his thesis is just that it's probably already built into the valuation. There just isn't much left. And can the story really be that good? If the growth rate slows down to 9.5% and they have 15% margins, which are their current best margins, he thinks the stock's only worth $63. 

I mean, is this a company that's in total decline now? I doubt that. One of the things that can happen, and we've actually invested in a couple of these, if they just are disciplined and focus on running the business well and use that cashflow to buy back stock at a reasonable price and pay down debt, I mean, this thing can still be a decent return, but we have no idea whether that's the path they're going to go down or not.

One piece that I think is really important and that you really need to realize, these growth stocks get priced at a much higher multiple than the market because they have great stories. As the story starts to change, that can become a big risk factor. And you're starting to see that now in Starbucks, where in the last five years, earnings are up 22%, but stocks only up 15%. If all things stay the same and actually margins have improved slightly from five years ago, You would maybe ask, well, why isn’t the stock doing better? It's because the story has changed a little bit. When you've got a stock trading at 23 times this year's estimates, I mean, it's not cheap. If they disappoint and have a hard time getting back to some growth again, what you quite likely will have is flat to maybe a little bit of earnings growth, but you'll have PE contraction and the PE will go from 23 to 15. It becomes more of a normally valued stock compared to the S&P 500. If you do the simple math on that and use the $4 estimate, a 20 multiple is an $80 stock. A 15 multiple is a $60 stock. I mean that there's no total return there. That's probably the biggest risk in this thing right now. The dividends could still grow some, but the total return, I think is at risk at the moment as you wait and see how this thing plays out. 

So to sum up, you may be wondering, are they buying in or not? Well, the answer is we're not going into Starbucks right now because we just don't feel like we have a clear enough path to where we can see this thing getting to a $4.20 dividend in the next 10 years. Now, that has nothing to do with what this thing does in the next six months or a year. If the new CEO shows some success— the stock went up almost 20% just when they announced he was coming in from Chipotle. You could easily get another 25% out of this with any success on his part at all, but we're playing a longer game than that. We're not interested in buying it, just seeing what happens in the next six months.

So now we're going to transition to an update and look at something that we're actually adding to currently. If you've listened to our podcast, we've made a few references to what we call our oil story and Chevron has been in our model portfolio since day one, going back to August of 2010. In the firm, we've owned it before that. But now that oil has backed off a little bit and Chevron has come back down below $140 a share, we are putting some more client money into it. Although the model portfolio is pretty much fully invested in it. 

As of today, it's at $139. It pays a $6.52 cent dividend, and that's a yield of just under 5%. The current payout ratio is 62%. That's been pretty consistent and that's relevant in this case, because when we're looking at dividend growth— they haven't raised the dividend because they've just been paying out more of their earnings. Earnings have kept up with their dividend payment and the rate that they raised it.

In the last five years, the dividend has grown by 35%. If you go back 10 years, the dividend has only grown by 43%. You always have to look behind these numbers and say, okay, what was going on? Why is that what it was? It's not too hard to figure out in 2020, I actually did a screenshot because I thought this will probably never happen in my lifetime again, when you had oil prices during the pandemic that went negative and stayed extremely low for months. It's amazing that Chevron even kept paying their dividend. But I think it's a great testament to how diversified the business is. It's not just tied to the price of oil. 

In our opinion, it's still definitely meets our dividend growth threshold. And going forward, in the case of Chevron, with almost a 5% dividend yield starting out, we don't need 7% growth for the next 10 years. And what I'm going to do now is give you a quick estimate of what that would look like. With earnings right now at around $14, that's where the estimate is for next year, all they have to do is grow earnings by $1 a share to $15 and at a 62% payout, you've got the dividend in 2033 at $9.28. That's a 4% dividend growth rate. When you throw the compounding factor in there over the next 10 years, we think it works with a lower growth rate. If the stock does grow its dividend to $9 and continues to trade in 2033 at a 4.6% dividend yield, the stock will have gone from $139 to $201. Our normal candidate for a dividend growth story we've said repeatedly is roughly between 2.5% to 4%. Well, when you're starting at 4.75%, this dividend doesn't even have to move at all. Just simple math with no compounding, if you just take $6.52 cents over 10 years, and it doesn't even grow, you have gotten $65. You've gotten half the value of your shares back just with the dividends. So you got a 50% plus return with no growth at all. 

Do I feel confident that they will be able to maintain earnings for the next 10 years? Yes. I think that's a pretty easy connection to make and it's much easier than trying to figure out how Starbucks is going to continue 7% a year.

It's debatable whether the industry has matured and it's actually going to start declining at some point, or whether it's going to continue to grow for a while. In the Chevron story, I don't think it matters because they are going to be like Exxon and some of the other majors. Occidental is one of Berkshire Hathaway's biggest buys. He's currently accumulating it relatively aggressively. It tells you that just because oil potentially matures, there's going to be major players out there. The thing about oil is even if the entire automobile sector was electrified, you still have oil in just pretty much everything you touch. Plastics, the carpet that you're probably standing on, and you're probably not going to have solar energy producing steel or concrete and asphalt. I mean, I could go on and on. 

The drilling count right now with rigs that are out in operation in the U. S., it's down to 582. That is, with the exception of the pandemic, we're at historic lows. Normally it runs a thousand or more rigs. So in time, that alone means there's just less supply coming onto the market. Everything winds up to, if the earnings just stay constant in this thing, I love starting at almost 5%, with any bump at all, which Chevron does every year, you're in great shape. And it's one of the few things that's really cheap in the marketplace. It trades at 12 times earnings. Will the PE expand? Probably not, partly because of politics, but if you remember listening to the IBM and Exxon comparison, a few podcasts back, sometimes these lower-valued stocks that have strong yields right out of the gate can do extremely well, even compared to growth.

What we have not said is Chevron has been a great dividend growth story. It has really helped our model portfolio because the dividend is higher on it. It's continued to raise it. So that has been a big positive for us, but what has been negative is the total return of Chevron since August of 2010 is up a little more than 200%, but the S&P is up considerably more than that. But you have to look at these situations and say, okay, over that period, you basically had an industry that totally collapsed and Chevron continued to perform. They continued to provide a return. I think going forward, I still have a lot of confidence in it and I doubt seriously whether you're going to have that kind of a collapse again. If we do, trust me, we're going to have other problems and we'll have plenty to talk about. It won't be good. 

So that's kind of where we're at on Chevron and why we continue to accumulate that. But as we wrap up here, I hope going through the Starbucks story that you found something worthwhile out of it. One of the things that we would say, even though we ended up with the conclusion that we're not going to put money in it, and the likelihood is we probably won't, unless the stock comes down a fair amount— Starbucks is a good one to probably have on the radar because you never know what can happen to these stories as they unfold. It's still a successful company and it still is very profitable. It generates the cash flow, but when you're starting out at a 2.5% dividend, you need growth for this to be a really successful story over the next 10 years. And then Chevron, in our opinion, with almost a 5% dividend yield starting out, it still works with a lower growth rate. But everything you look at, and when you're looking at, especially at a new position, you just don't know. You have to really put it together, look at it and say, is this thing going to fit? There are no simple rules that you follow that make your portfolio perform over time. It's a constant work in progress.

If you enjoyed today's podcast, please leave us a review and subscribe. If you would like more information regarding dividend growth or our investment strategy, please visit growmydollar.com. There you will find previous episodes and also our monthly newsletter. If you have any questions or anything to add to today's episode, please email Ethan@growmydollar.com. 

Past performance does not guarantee future results. Every investor should consider whether an investment strategy is right for them and all the risk involved. Stocks, including dividend stocks, are volatile and can lose money. Denewiler Capital Management may or may not have positions in the publicly traded companies mentioned herein.