An ongoing legal dispute between Kraft
(KRFT)
and Starbucks (NASDAQ:SBUX)
may end up providing investors with a solid investment opportunity with the
coffee retailer. The two companies have
been battling
in court since 2010 over an agreement under which Kraft distributed Starbucks’ packaged coffees,
including whole beans and ground coffee, to grocery stores and other retailers. Kraft claims that Starbucks unilaterally
decided to end their agreement, and Starbucks says that Kraft failed to
aggressively promote its brands, which include Seattle’s Best Coffee, in
stores.
The deal between Kraft and
Starbucks began in 1998, when Starbucks was selling its coffee in just 4,000
stores with annual sales of about $50 million.
When Starbucks backed out of the agreement in 2010 sales had grown to
about $500 million a year, and Starbucks packaged coffee was sold in 40,000
stores across the United States and Canada.
Starbucks reportedly approached Kraft in August 2010 about ending the
partnership and made a $750 million offer to buy out Kraft’s rights in the deal. Kraft said the offer was below fair market
value and declined. In October 2010,
Starbucks sent a letter to Kraft stating that Kraft had breached the agreement. Starbucks said that Kraft had done a poor job
of marketing their products and had failed to share important information. They also claimed that that Kraft’s Yuban
coffee was unfairly competing with Starbucks.
Kraft defended its efforts on behalf of Starbucks, citing strong growth
in Starbucks sales during their agreement.
Since then the companies
have continued to carry their disagreement through various legal proceedings
and arbitration. In April, Starbucks
announced in its quarterly filing
that it now expects a binding decision from an arbitrator to be handed down in
the second half of its fiscal year ending September 2013.
The expected end to this
legal battle may provide investors with a unique opportunity. Moses
Li states that, “analysts
are expecting SBUX to pay at least $1 billion in addition to any legal fees to
Kraft for damages. Although these
expectations are general knowledge to the public, SBUX shares are hitting
all-time highs, indicating that it has not been reflected in the valuation.
In addition, with roughly only $1.67Bn in available cash, it is safe to
assume that SBUX will tap into debt options in order to finance the settlement
and keep on-going operations. The new debt plus the payment for the settlement
will almost definitely harm the company's bottom line. If we combine this with
the fact that the stock is more sensitive to downside news, SBUX may take a dip
after the lawsuit ruling.”
Li also goes on to explain, Starbucks
is on the path to becoming a large international powerhouse. Furthermore, the
company has stated that it expects China to easily outpace the Canadian
business revenues within the next couple of years. Most of these growth plans
are set to impact EPS in FY2014, FY2015, which explains the current valuation; investors are paying a
premium for the future's potential. We also cannot forget the
continued success of SBUX's loyalty cards, channel development, and food sales
growth. Much of the growth's future success depends on the competencies of
management, but we have no reason to doubt Mr. Schultz and his ability to grow
a company aggressively.”
Li further explains the potential
investment opportunity that could arise out of this lawsuit. “Last summer, SBUX
took a 29% plunge from highs of $61.67 due to general market volatility and
poor earnings calls. Of course, by no means can we assume an identical decline
if SBUX loses the lawsuit, but for discussion's sake, let's examine a similar
decline after the lawsuit decision or another potential market correction. With
15% from today's share price of $62.46, the price will be $53.01. Furthermore,
forward P/E will become 21.7. At these hypothetical valuation levels, Starbucks will be more than
attractive because you will be buying the future's growth with a fair or even
cheap valuation.”
In light of all of this, it might
be well worth your while to take a serious look at Starbucks as a potential
long term investment.
To read all of Moses Li’s
analysis, visit http://seekingalpha.com/article/1484431-starbucks-kraft-lawsuit-provides-a-rare-investment-opportunity
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