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Starbucks For The Long Term

In the early 1970s the “Nifty 50” were all the rage – growth stocks like International Business Machines (NYSE:IBM), Xerox (NYSE:XRX) General Electric (NYSE:GE), Coca-Cola (NYSE:KO), Procter & Gamble (NYSE:PG), Sears Roebuck (NASDAQ:SHLD), Johnson & Johnson (NYSE:JNJ), McDonald’s (NYSE:MCD), Polaroid and Eastman Kodak (NYSE:KODK), to name a few. In 1973-1974 these high flying growth stocks got hammered back down to reality, and investors vowed to never again pay 30 times earnings for a stock.

In Jeremy Siegel’s “Stocks for the Long-Run” he points out that the Nifty 50 were overvalued in 1972 right before the drop, but only by a small margin. From the December ’72 peak to June 1997, an investor who rebalanced would have seen 12.7% annualized return vs 12.9% return of the market (or 12.4% if never rebalanced). So even if you bought the bunch at the worst possible time, you still got market returns.

Keep in mind, that includes the good with the bad. If y ou had invested in Phillip Morris (NYSE:PM) you would have killed it. Reverse engineering it, and looking at earnings and dividends, investors should have bid up Phillip Morris to 78.2 times earnings in 1972 according to Siegel’s math in the book! Xerox was bid up to a 45.8 PE but should have only traded 18.3 times earnings, the market rate at the time. Coca-Cola had a 46.4 PE in 1972, but the math says it should have traded at over 90X earnings! Imagine that, the stock with the 46 PE was trading at half its value!

During the ’73-’74 bear market, investors were cursing their ’72 buys, and pundits claimed they were overvalued mistakes. Siegel’s research says otherwise. Even at the peak investors were rational in bidding up the Nifty 50 to a collective 41.9 PE vs. the market’s 18.9 PE. The reason: growth.

Which leads me to Starbucks (NASDAQ:SBUX). This company is about as guaranteed growth as you can get. Globalization is Americanization, and Starbucks is taking over the world.

In the mid-’90s I saw something on TV where there was a Starbucks barista and he said he was making more money from owning the stock than from sweeping the floors and serving coffees.

But but but who would pay $2- $4 for a cup of coffee?

If you’ve read a Starbucks Seeking Alpha article you always see Bob from Nebraska. You know Bob. He wonders why Somebody would pay $2 for a cup of coffee when he can make it at home for 20 cents! Let’s say you live in a city and want to get out of your apartment to your 3rd space. You go alone, or you meet up with friends. You meet at Starbucks, sit in comfortable chairs and ambiance and chat for an hour or two. Cost $5. That’s a bargain.

“The Reserve Roastery & Tasting room is overpriced. Who would pay $10 for a cup of coffee?”

< p>How do bars stay in business? I mean why go pay $4-$9 per beer when you can have one at home for less than a buck? What about movie theaters? Why go spend $10-$15 on a movie when you can wait 6 months and watch it for $1 or maybe free? Why spend $30 on baseball game tickets when you can watch it on TV for free? The difference is experience.

The Starbucks Experience is built upon superior customer service, as well as clean and well-maintained stores that reflect the personalities of the communities in which they operate, thereby building a high degree of customer loyalty. This is different than McDonald’s, Duncan Donuts (NASDAQ:DNKN), Costa Coffee (OTCPK:WTBCY). If you want to drink a $1 coffee and smell burning pink slime, fine – there are literally millions of people that will pay the extra buck or two to sit in a more comfortable chair and NOT smell that.

Starbucks is about as guaranteed growth as you can get. It’s like investing in McDonald’s or Coca-Cola 50 years ago.

I used to think there was no more room in America, but every time a new subdivision is created they put in a Starbucks at the strip mall next to it. They are opening a store in China every 15 hours, a growth rate they project for decades, and one day China will be a bigger for Starbucks than America. There is so much room to grow in Asia, but Europe will also grow. When I see Starbucks in Europe, they are always packed. Is Starbucks better than an Italian coffee shop? No, but Italy has tons of tourists and Italians like America.

The easiest way to add to growth is adding stores. They are cash machines. Each store can also increase profitability. They make roughly 75% from beverages, 20% food and 5% “other”. Per unit economics will increase from the loyalty cards, the app to speed up the lines and there is real opportunity for food. Do you want a coffee or a coffee and pastry? Fruit? The breakfast quiche is amazing.

Also, don’t forget the roasteries in Seattle, Shanghai, New York, Milan, Tokyo and Chicago. These will continue to strengthen the brand and are additional opportunities for growth.

Here’s a litmus test. If Starbucks were my #1 position (it is not) I would sleep well at night.

If you had invested in Starbucks in the 1990s, you are very happy as you destroyed the market.

But just because you didn’t invest in the 1990’s doesn’t mean you can’t beat the market with Starbucks. We also saw Starbucks beat the market handily over the last 10 years.

Revenue growth has been trending down. At just under $60 per share with a 30 PE, Starbucks is trading for around the same price it was in July 2015. Revenues, earnings and dividends have increased since then.

Bears want to nitpick about store traffic/comps, and many are calling for Starbucks demise. Howard Shultz addressed that head on – you can practically hear him pound the table in the latest earnings report:

Starbucks Coffee Company is built to last. Starbucks Coffee Company is built to build a great and enduring company. And there’s no question in our mind as we sit as a management team and as we address you today on the heels of a tough first half that our best days are in front of us. And for those of you who have covered the company for many, many years, who know me personally, I would not be here banging on the table and telling you how strongly I feel about the growth, development, and what we have in store in terms of the innovation of the company , both inside the four walls of our store, the building of the Reserve brand, the unbelievable experience, the roasteries, what’s going to happen in all these cities

Management reiterates long-term guidance of 10% on the top line and 15% to 20% on the bottom line.

Don’t forget, folks, this company is still in growth mode. They are funding a new store in China every 15 hours. This stock is a prime candidate to be a future dividend growth investment as well. Once Starbucks conquers the world then they can increase their payout ratio and give their FCF to their investors.

So let’s say Starbucks grows earnings @ 20%. We are on course for $2.10 this year. In 10 years we could see $13 in earnings. Let’s say the PE cools down to 20 in 2027 and we are looking at $260 per share. If Starbucks were able to grow EPS 20% for 20 years, earnings would be 80 and a 20 PE would give us $1,600 per share in 2037.

If earnings grow @ 15% in 10 years we are at $8.5 in e arnings and with a 20 multiple we get a $170 share price. If it grows 15% for 2 decades we get to $34 earnings and a $680 value with a 20 multiple.

If earnings ONLY grow @ 10% in 10 years we are at $5.44 EPS and with a 20 multiple we are at $109. If we grow earnings for two decades at 10% we get to $14 EPS and with a 20 multiple a $280 share price.

Imagine decades in the future when they “max out” on new stores and the company can distribute 75% or more of earnings to shareholders in the form of dividends and buybacks. THAT is enough to get young Starbucks shareholders very excited about the future.

Now, I’ve been here almost 40 years. I’ve seen many cyclical changes in our core business. And I can tell you sitting here today, I have never been more confident that the comp growth that we have seen in the first half of the year, over time, beginning in the second half of the year and beyond, will be a distant memory. The pipeline for innovation, both in terms of product development, digital development, mobile development, and if you just look at what happened in the last two weeks, was something that wa s really probably the most stunning example of our understanding of digital and social media and Instagram, what happened with Unicorn, drove significant traffic, incrementally, awareness, brand affinity. And just stay tuned, because we have a lot more coming. – Howard Shultz

The future is very bright. New coffees, tea, promotions, integrating technology. What about adding ice cream? We can’t predict what management will do in 5-20 years but we are in good hands.

This is one of those stocks Professor Siegel talks about. A true growth stock can be worth a lot more than people “think” it is, even if our next correction is just over the horizon.

Long Starbucks for decades to come.

Disclosure: I am/we are long SBUX, IBM, KO, MCD, JNJ.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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1 Thing About Pfizer, Inc. Stock That You Might Be Overlooking”

There are several things about Pfizer (NYSE:PFE) stock for investors to like. Its dividend is a biggie. The potential for growth from products such as Ibrance and Xeljanz definitely makes the list. So does growth-driving newer drugs like Eucrisa.

But what about Pfizer’s essential health business segment? This business might seem boring compared to the company’s innovative health segment, which claims those exciting products mentioned above and plenty more. However, there’s a lot for investors to like in this often-overlooked part of Pfizer. Here’s why.

Missing jigsaw puzzle piece under magnifying glass

Image source: Getty Images.

Financial contribution

If you like Pfizer’s dividend (and who doesn’t?), you can thank the company’s essential health segment for funding much of it. Last year, the segment generated revenue of $23.6 billion — nearly 45% of Pfizer’s total revenue.

The essential health business, though, includes Pfizer’s drugs that have lost patent exclusivity. Does this make the segment less profitable? Not really. The essential health segment generated$12.9 billion of income before tax. That’s roughly 80% of the amount that the higher-growth innovative health segment generated. Essential health remains a quite profitable business for Pfizer.

We could look at this income figure in another way. Pfizer’s operating cash flow in 2016 was $15.9 billion. Without the essential health business, that figure would have been much lower. And it’s quite possible, the dividend would have been lower, too.

Biosimilars

Biosimilars comprise the fastest-growing part of Pfizer’s essential health business. Revenue from biosimilars more than quintupled in 2016 from the prior year. Granted, it’s still a small part of the business. However, biosimilars should play an increasingly more important role for Pfizer in the future.

Success so far has stemmed from Inflectra, Pfizer’s biosimilar to Johnson & Johnson’s (NYSE:JNJ) Remicade. Inflectra launched in the U.S. in October of last year and entered the European market (under the brand name Remsima) in 2015.

Johnson & Johnson is putting up a fight, however. The healthcare giant termed Pfizer’s introduction of Inflectra as an “at-risk launch.” J&J is challenging Pfizer in court over potential patent infringements and intends to compete through discounts, rebates, and other measures. That threat isn’t stopping Pfizer from moving forward.

Pfizer also awaits regulatory approval for another biosimilar to Amgen’sEpogen. In addition, the company’s pipeline includes five late-stage candidates that are biosimilars to top-selling drugs.

Pfizer’s essential health group president, John Young, recently stated that the global biosimilar market is projected to grow from just under $2 billion today to $15 billion by 2024. It’s a significant opportunity for Pfizer.

Sterile injectables

Pfizer’s 2015 acquisition of Hospira positions the company as a major player in the sterile injectables market. Last year, Pfizer’s essential health segment made $6 billion in sales from sterile injectables. That figure seems likely to grow considerably.

Over the next three years, Pfizer expects to launch over 140 new sterile injectable products. To put that into perspective, the company launched 24 new products in 2016. The company’s pipeline includes more than 250 sterile injectable products across 14 therapeutic areas.

The global market size for sterile injectables currently stands at around $80 billion. This market is projected to grow at an annual rate of 5% over the next several years. Pfizer should see more than its fair share of that growth.

Anti-infectives

Another key part of Pfizer’s essential health segment is its anti-infectives business. Pfizer is the No. 1 anti-infective company in the world with $3.3 billion in sales last year.

The World Health Organization (WHO) has called anti-microbial resistance as one of the most serious threats to global health. This problem could be compounded by an aging global population that is more at risk of infections.

Pfizer essential health should be in a great position to grow its anti-infectives business, particularly in emerging markets. The company’s acquisition of AstraZeneca’s small molecule anti-infectives business should give it an even greater competitive advantage.

The bottom line

The essential health business won’t ever be the growth driver for Pfizer that its innovative health segment is. However, there are several growth opportunities for essential health in multiple markets.

Most important for investors, Pfizer’s essential health business should continue to generate solid cash flow. That translates to dividends and possible additional acquisitions to further Pfizer’s growth more in the future.

Johnson & Johnson May Already Have Its Remicade Replacement Well in Hand”

When it comes to safe stocks, there may be none safer than healthcare conglomerate Johnson & Johnson (NYSE:JNJ). Johnson & Johnson is often a staple holding for income seekers, conservative investors, and even value investors. It has a 54-year streak of increasing its dividend payout, which should almost certainly become 55 years come April, and it’s one of two remaining publicly listed companies with a “AAA” credit rating from Standard & Poor’s. That’s a higher credit rating than the U.S. government.

The secret to J&J’s long-term success has been its business structure. Instead of operating as one giant company, it’s composed of more than 250 subsidiaries, which allows management to play with the dominoes, if you will, from time to time, in order to boost growth. It’s been able to divest slower-growing assets and acquire pharmaceutical products in recent years to boost its near- and intermediate-term growth prospects. Pharma is, without question, the largest contributor to its gross margin and top- and bottom-line growth.

Increasing stacks of pills next to a bottle atop cash, symbolizing growing drug sales.

Image source: Getty Images.

Remicade woes take shape

However, J&J might have a big problem on its hands. Its top-selling drug, Remicade, an anti-inflammatory treatment for a host of diseases, is facing competition from the recently launched Inflectra, a biosimilar drug developed by Celltrion and marketed by Pfizerat a 15% discount to Remicade’s list price. Sales of Remicade stumbled by nearly 2% in the U.S. during the fourth quarter, signaling that sales of J&J’s nearly $7 billion drug could begin to head in reverse.

For its part, Johnson & Johnson recently announced the pricey $30 billion acquisition of Actelion (NASDAQOTH:ALIOF), a Swiss-based developer of specialized lung-disease drugs to help immediately stem the pain from lost Remicade revenue. Actelion’s Opsumit and Uptravi are each expected to generate in the neighborhood of $2 billion in peak annual sales.

The Actelion transaction, however, may not have even been necessary if J&J hadn’t been catering to the short-term mind-set of Wall Street. In fact, J&J may have its Remicade replacement already in hand.

Johnson & Johnson already has its Remicade replacement Box and vial of Remicade.

Image source: Johnson & Johnson.

Earlier this week, Danish drugmaker Genmabreported its full-year results and noted that multiple myeloma drug Darzalex, which is marketed by Johnson & Johnson, is fully on track to generate $1.1 billion to $1.3 billion in full-year sales in 2017. The drug wound up generating $572 million in sales in its first full year following its approval in Nov. 2015. Genmab is entitled to receive tiered royalties on the sale of Darzalex, and guided analysts to expect $132 million to $156 million in milestone payments this year based on the aforementioned $1.1 billion to $1.3 billion in expected sales.

While the expected doubling in Darzalex’s sales might wow you, the drug appears to just be getting started. According to Genmab CEO Jan van de Winkel in an interview with Reuters, in a utopian scenario where Darzalex expands into other blood cancer indications, and perhaps even solid tumors, it could generate as much as $13 billion annually in peak sales. Van de Winkel believes that Darzalex could “definitely” generate $9 billion in peak annual sales, which for J&J would mean replacing every cent Remicade is currently providing (if not more).

Multiple myeloma is a growing market for nearly all

Multiple myeloma diagnoses have been on the rise, largely as a result of refined methods of detecting the disease earlier, which, for investors, means that the size of the pie for large multiple myeloma players — Genmab/J&J, Celgene, and Amgen– is growing. The duration of treatment for multiple myeloma patients has improved as well, which is largely a testament to the improved tolerability and outcome of next-generation medicines. This would also mean strong pricing power for these drugmakers, too.

Box and vial of Kyprolis.

Image source: Amgen.

With Darzalex mostly dominating the third-line and higher dosing, and being administered in combination with Revlimid, it’s really of no danger to Celgene’s beast of a multiple myeloma drug.

However, Darzalex may be a bit of a concern for Amgen’s Kyprolis. Though the two drugs have never gone head-to-head in clinical studies, they did face very similar circumstances in the phase 3 studies that led to their third-line and up multiple myeloma approvals with the Food and Drug Administration. Both drugs treated patients who’d progressed on an average of five prior lines of therapy, but Darzalex delivered a 29% objective response rate compared to Kyprolis’ 23%. Again, this is pure coincidence and not causation at work here, but this trial data could be coercing physicians and patients to choose Darzalex over Kyprolis.

Mid-single-digit growth is very achievable

For companies the size of J&J with nearly $72 billion in annual sales, mid-single-digit sales growth is something quite exceptional and hard to come by. However, with J&J shifting its business over the past couple more toward pharmaceuticals, it’s becoming very achievable.

Johnson & Johnson outlined plans in May 2015 to file 10 novel drugs for approval with the FDA by 2019 that had the potential to reach at least $1 billion in peak annual sales. Darzalex was just the first of that bunch to get approved. If its first drug has “definitely” $9 billion in peak annual sales potential according to Genmab’s CEO, imagine what the remaining nine drugs could do for its top and bottom lines.

My suggestion would be to stop worrying so much about Remicade because J&J may already have a Remicade revenue replacement ready to rock n’ roll.