Income Investors Perk Up to Starbucks

The world’s largest chain of coffee shops is putting investors in a good humor leading into their annual shareholder meeting in Seattle where they plan to outline the way forward. Starbucks (SBUX) announced that it will institute a cash dividend for the first time in their history as a public company. The first payout scheduled for April 23rd will be $.10 per share, and is expected to recur on a quarterly basis as management said they want to continue to payout 35% to 40% of net income in dividends to shareholders. The implied annual yield puts the current figure at 36% of this year’s earnings, and will give the stock a yield of about 1.6% right away.

In addition to the instatement of a dividend, the company also announced that they plan to greatly expand their share repurchase authority. The plan already in place still has 6.3 million shares authorized for repurchase, but the board is allowing an additional 15 million shares on top of that. This is a significant announcement, but as we know share repurchase authorizations do not require the company to actually buy the shares. So, if management decides there are better uses of capital when the time comes, they can scale the plans back if so desired. At any rate, this is a show of confidence in the direction of the company that investors like to see.

To be sure, these corporate actions continue the company’s transition to a more moderate growth trajectory rather than the breakneck pace that had characterized Starbucks’ past. The recession hit Starbucks hard and they were forced to redirect towards streamlining operations and cutting costs. Starbucks had grown so rapidly that it had saturated many urban areas, and underperforming stores were shuttered and employees let go. Sales have finally started to show improvement, and the company maintains its cost conscious focus. Instead of opening large amounts of new stores, they are focusing on other, less capital intensive paths to growth; including, its new Via instant coffee product and licensing deals with Burger King (BKC) for example. This strategy will likely result in moderate single digit revenue growth in the next few years, but the leaner cost structure should bulk up margins in the years to come. Consensus analysts’ estimates have earnings growing at 13.5% in fiscal 2011 about 4x faster than the expected sales growth rate.

We recently downgraded Starbucks to Fairly Valued from Undervalued, but our rating is very near the threshold between the two. The stock currently trades at the low end of its historical range of price-to-cash earnings; currently 16.4x versus the historical range of 15.8x to 28.0x. The current price-to-sales of 1.84x compares favorably to the historical range of 1.93x to 3.33x. In our rating this week, we have our dividend analysis as a neutral (as we do for any company that has not historically paid dividends); however, SBUX’s new dividend will factor positively in our analysis in the coming weeks and may be enough to prompt an upgrade.

It appears the company is finally emerging from a painful period of restructuring, and anticipates bringing in over $1 billion in free cash flow this year. Starbucks has emerged from the recession leaner and stronger than before, and growth is not dead as international opportunities are still ripe. So, income investors should take notice of the new Starbucks as it seems they have rapidly turned a growth machine into a cash machine, and they have stated there intention to pay a good portion of that to shareholders in the future.

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