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The American University in Cairo Acct 501 Spring 08 Starbucks Financial Analysis Years 2003-2007 Presented to: Dr. Adel Ibrahim Presented by: Ahmed El-Shorbagy 800-07-0477 Ahmed Tawfik 900-98-5749 Mahmoud El Gindy 800-07-0417 Mohammed Abo Solyman 900-02-1301 Mohammed Hassan 800-07-1982 Table of Contents Executive Summary3 Introduction4 Financial Statement Analysis5 Consolidated Balance Sheet5 Consolidated Income Statement5 Consolidated Cash Flow Statement5 Consolidated Statement of Changes in Owner’s Equity5

Profit Margins6 Gross Margin6 Net Profit Margin6 Liquidity Measures7 Current Ratio/Acid Test (Quick) Ratios7 Financial Leverage Measures8 Leverage ratio/ debt ratio/ debt to equity ratio9 Investment Returns Measures9 Return on Investment (ROI)10 Return on Equity (ROE)10 Management Efficiency Measures10 Asset Turnover10 Inventory Turnover11 Conclusion13 References14 Executive Summary As one of the most recognizable brands worldwide, Starbucks is considered a monumental success story and an investors’ paradise.

In this report, through interpreting the financial statements from 2003 on to 2007, we can a clear and concise picture of the biggest American coffee corporation performance. Our Evaluation and analysis of the company’s performance starts with Gross Margin and Profit Margin both of which shows the company operating on a satisfactory level comparing to the industry. Moving on to Liquidity measures, we notice that the company’s trend is to keep their cash levels at minimum. This can be explained by the explosive expansion of the chain worldwide and is another indicator of Starbucks’ confidence in its future plans.

Our next measures are Financial Leverage ratios. Starbucks relies relatively heavily on debt to finance its ambitious expansions. Solid sales and revenues ensures the company’s capability of fulfilling their obligations in due time. This is further explained by observing both the ROI and ROE, Both of them show high returns compared to the industry’s standards. Throughout this report we noticed that the combination of administrative and executive performance is sure to keep credit flowing to the company’s projects.

This fact can be illustrated by analyzing some of the management efficiency measures. Through the asset turnover and inventory turnover ratios, the managerial side of Starbucks is put under the lens and it’s clear that the company’s doing a great job increasing the efficiency and productivity of its operations. With more than a 100 branches opening every month, Starbucks offers a great opportunity for investments and through this report, we hope we have made investors decision easier and profitable.

Starbucks is arguably the largest coffee company in the world today. Starbucks offers a wide variety of products ranging from fresh, rich-brewed coffees, Italian-style espresso beverages, premium teas, cold blended beverages, a variety of complimentary food items, and coffee related accessories. In addition, Starbucks also markets books, music and film via their “Starbucks Entertainment” division and different brands. Founded originally in Washington, Starbucks has a goal of becoming a global market leader in the coffee business.

Having such a goal and determination, Starbucks is now the largest coffeehouse company in the world; it’s a market leader in the US (domestic market) and has invaded European markets, and recently the Middle East regions as well. To do so, Starbucks has made several joint ventures around the globe to well develop its brand image in the market, and this has proved to yield significant figures. Introduction Originally, Starbucks was found by three partners, Jerry Baldwin, Zev Siegel, and Gordon Bowker. However, it was not until businessman Howard Schultz took over that Starbucks started the successful path.

Having set a plan to open locations in the US, Starbucks invaded the global market in 1996 by starting up a location in Tokyo, and from then on there are Starbucks all over the globe (Starbucks has opened in Egypt in the last couple of years). In this report, the performance of Starbucks over the past few years has been analyzed. The financial statements have been obtained from the years of 2003 up to 2007, and have been analyzed using the horizontal analysis, vertical analysis, and the ratio analysis (depending on what exactly is being analyzed). Financial Statement Analysis

Before heading off to analyzing the financial statements of Starbucks, below are summaries of the consolidated financial statements of the five years under focus (see References for full details). From this point on, all the figures are in millions of dollars. Consolidated Balance Sheet | |2003 |2004 |2005 |2006 |2007 | |Total Current Assets |909. 98 |1,350. 9 |1,209. 33 |1,529. 79 |1,696. 49 | |Total Assets |2,778. 3 |3,386. 54 |3,513. 69 |4,428. 94 |5,343. 88 | |Total Current Liabilities |574. 21 |746. 26 |1,227 |1,935. 62 |2,155. 57 | |Total Liabilities |707. 42 |916. 33 |1,423. 43 |2,200. 44 |3,059. 76 | | | | | | | | Consolidated Income Statement |2003 |2004 |2005 |2006 |2007 | |Total Revenue |4,075. 52 |5,294. 25 |6,369. 3 |7,786. 94 |9,411. 5 | |Gross Profit |1,014. 51 |1,312. 64 |1,598. 18 |1,920. 34 |2,196. 48 | |Operating Income |420. 85 |606. 49 |780. 52 |893. 95 |1,053. 95 | |Net Income |265. 36 |388. 8 |494. 37 |564. 26 |672. 64 | Consolidated Cash Flow Statement | |2003 |2004 |2005 |2006 |2007 | |Cash from Operating Activities |616. 12 |862. 92 |922. 92 |1,131. 63 |1,331. 22 | |Cash from Investing Activities |-616. 42 |-753. 89 |-220. 62 |-841. 04 |-1,201. 95 | |Cash from Financing Activities |30. 76 |-66. 55 |-673. 3 |-155. 33 |-171. 89 | |Net Change in Cash |-31. 35 |138. 8 |28. 76 |45. 59 |33. 74 | | | | | | | | Consolidated Statement of Changes in Owner’s Equity | |2003 |2004 |2005 |2006 |2007 | |Total Equity |2,071. 11 |2,470. 21 |2,090. 6 |2,228. 51 |2,284. 12 | Profit Margins The profit margins include the gross margin and the net profit margin. Analysis of this section follows the vertical analysis method, where a percentage of totals of the same year is used. The following table is the basis of the discussion. This table shows the contribution (as a %) of the gross margin and net profit from the total revenues of the year. [pic] Gross Margin The gross margin indicates how efficiently a company manages its largest assets and biggest costs. The company’s gross margin has held steady, in the 23% to 25% range, over the last five years.

This indicates that no matter how the economy is performing, Starbucks has been able to efficiently manage its costs structure. It has done an excellent job of managing it’s cost structure even during a difficult stretch in 2006, which included elevated commodity and fuel costs. Its true there has been decrease in the margin (increase in cost), but when compared to the industry, Starbucks is performing at a satisfactory level (23% in 2007 compared to 19% in 2007 for the industry). Thus, one can see the effect of signing agreements between Starbucks and its suppliers to keep cost fixed of supplies ( from the annual report)..

Net Profit Margin The net profit margin indicates how much profit a company makes for every $1 it generates in revenues. Starbucks’ net profit margin was 7. 1% in 2007. Although it decreased slightly from 7. 3 in 2006 and 7. 8% in 2005, the product of the aforementioned costs, it still surpassed the rate achieved in 2003. This is an encouraging sign for the company; this is highlighted with the fact that the decrease in the net income is not due lower revenues, but rather due to increase of different costs. For example, the acquisitions the company made and the opening of new retail stores increased the depreciation expenses.

Also as mentioned in their annual report, additional employees to support continued global growth were hired, and higher professional fees in support of global systems has been paid. When compared to the industry, Starbucks margin is not as high as the industry norm (8. 6% for the industry). This suggests that other competitors of Starbucks are competing aggressively and achieving higher profits. However, the steady increase in revenues and the acquisitions the company has made all suggest that net profit will go back to increase. Liquidity Measures

The liquidity measures involved in the analysis are the current ratio, and the acid test. The following graph is a horizontal trend analysis of the two ratios discussed. The values for the year 2003 have been taken as a base and thus have a value of 100, the years to follow would increase or decrease than the 100 according to their relative figures. [pic] Current Ratio/Acid Test (Quick) Ratios When comparing the two ratios of Starbucks as opposed to the industry, it is clear that both the current and quick ratios of Starbucks are low, and have decreased from the first year greatly ( in 2007 current ratio decreased to 0. from 1. 5 in 2003, and acid test ratio decreased to 0. 3 in 2007 from 0. 8 in 2003). This reflects clear trend from management to keep cash in hand as little as possible to use it in another investments. The low ratios are not a problem or alarming of any sort of danger. The continuity in growth and increase in revenues and profit gives confidence in management and that the creditors’ obligations will be met. In addition, there are two more reasons for not to be alerted by the low ratios. First, Starbucks is doing great job converting their receivables into cash.

The approximate number of days in account receivables is 11 for 2007. This means that the company collects its cash fast. Second, the times interest earned ratio (the ratio of operating income to interest expense) which indicates the firm’s ability to earn enough to cover its annual interest requirement, is high for Starbucks. in 2007 it was about 10, that is Starbucks income from operation was 10 times higher than its interest expense. This is also indication that Starbucks can borrow more and use more debt to finance its activities and growth. A more detailed discussion of the this will come in the section.

Financial Leverage Measures The ratios analyzed in this section are the leverage ratio, the debt ratio, and the debt to equity ratio. The table below has the figures of the ratios of the five years plotted to have a vision of the trend of these ratios as the years progressed from 2003 to 2007. [pic] Leverage ratio/ debt ratio/ debt to equity ratio The change in debt ratio from 25% in 2003 to 57% in 2007 says a lot about Starbucks financing policy. It says that company in past years used to finance all its acquisitions and expansion activities from equity and cash flows.

The continuous success seems to have encouraged the company to adapt rapid international expansion. The expansion required huge finances that the company thought to provide through debt. Compared to the industry, Starbucks leverage ratio, debt, and debt to equity ratios are higher than the industry (2. 2 against 2. 0 leverage, and 0. 57 against 0. 45 debt/equity ratio). And as has been mentioned before, even though these ratios are high compared to industry, other measures and indicators suggest that it is safe and that there is even more room for Starbucks to increase its expansion and growth through debts.

The company earns from operation already 10 times more than its interest expense. The cash flow generated from operations is far higher than the net income itself. There is steady and continues growth in revenues and sales. There seems to be for Starbucks room to increase it’s debt to increase its expansion and growth without straining its daily operations. Investment Returns Measures The measures taken here are the Return on Investment (ROI) and the Return on Equity (ROE) measures. Following is a plot of the ROI and ROE along the years. [pic] Return on Investment (ROI)

This measure has steadily improved over the last five years. It has grown from 10% in 2003 to nearly 13% at the end of fiscal 2007. The company’s assets are returning nearly $0. 13 on $1. 00 invested by the company. This gives Starbucks, as well as the investment community confidence that future investments will provide a nice return for the company. Return on Equity (ROE) Starbuck’s ROE is high compared to the industry (29. 8% compared to 25. 8% industry ). Looking at the whole trend for the last 5 years, the ROE skyrocketed. The intense repurchases Starbucks is doing also enhanced shareholders value.

Of course one reason also behind this accelerating increase in ROE is the high leverage Starbucks is using in its business from creditors. When the ROE in broken down to the Du Pont model, The Du Pont analysis shows that the ROE has increased over the period of five years mainly due to an increase in the financial leverage ( from 1. 3 to 2. 2), followed by the asset turnover (from 1. 6 to 1. 9) and the net profit margin( from 56% to 71%). Management Efficiency Measures Asset turnover and inventory turnover constitute the management efficiency measures in this section. Asset Turnover

Asset turnover relates to the efficiency with which the firm’s assets are used in the revenue generating process. As evident in the graph below, Starbucks ratio stands at a healthy 2. 0(compared to 1. 7 of the industry). More importantly, this ratio has improved every year since the beginning of this decade. This indicates that Starbucks has done great job integrating the new assets in the revenue generating process. This is a proof of management efficiency. [pic] Inventory Turnover The inventory turnover is lower than that for the industry (11 compared to 19 of the industry).

This also can be seen in the number of days sales in inventory (which reached 35). This is an area of weakness in Starbucks’ management. The high inventories maintained require inventory needs to be financed with debt or owner’s equity. This reduces ROI. This is an area for management to try to improve. It seems they have been working on it. The number of days sale in inventory reduced from 40 in 2003 to 35 in 2007. [pic] . Conclusion To make an investment decision, an investor needs two types of information the Trend analysis for past data and the Projections for future development and as illustrated in the above sections of the report.

Starbucks financials can be classified under a good financial performance with net revenues for 2007 more than double (precisely 2. 53) when referred to 2003. This growth can be attributed to the international expansion strategies followed by the company which is opening around 100 new outlet per month world wide and though the wide substantial expansion in the number of retails of Starbucks plays a major role in the earning increases, however the mixture of the following factors played a major role in slightly lowering the margins for Starbucks, these factors are mainly. Increasing the costs of distribution. • Increasing value of store rental costs. • Increase in wages costs. Though the lower margins of the last year relative to the previous 2 years, Starbucks succeeded in keeping there market leader position via variant operations policies such as, securing the commodities inventory stocks as early as possible to avoid the sudden and high increases in commodities prices. Worth to mention that Starbuck bought back its own shares twice in the recent years with value of 1. billion $ in 2005 and 475 million $ in 2006, which adds a further stability to the stock price and enhance the shareholder value. Finally after the all the above financial analysis we can conclude that Starbucks would be a good investment with a stronghold on its market position, and remains a powerful market leader amongst competition ranging from coffeehouse franchises to major fast-food companies. References “Annual Reports. Starbucks. * Marshall, David H, et al. Accounting: What the Numbers Mean Eighth Edition. New York: McGraw-Hill, 2008. “Starbucks. ” MSN Money. * Starbucks. Starbucks Corporation. [www. starbucks. com] “Starbucks. ” Wikipedia: The Free Encyclopedia. 23 May, 2008. * These are the references used to obtain the financial statements for the years 2003-2007. Due to the massive length of these documents they are not printed in an appendix.

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