SBUX DNKN Final Report

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Company valuation

Final report

Starbucks vs. Dunkin’ Donuts

CERTIFICATE OF AUTHORSHIP: We certify that we are the authors. We have cited all sources

from which we used data, ideas, or words, either quoted directly or paraphrased. We also certify that

this paper was prepared for this course specifically.

Names & Signature:

Huntley Platt

Gyula Magyar

Kostiantyn Riabkov

Istvan Szabo

CEU Business School K/EMBA, 2016 summer

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Table of contents

1 General overview ............................................................................................................................ 3

1.1 Industry outlook ...................................................................................................................... 3

1.2 Starbucks ................................................................................................................................. 3

1.3 Dunkin’ Donuts ....................................................................................................................... 4

2 Discounted Cash flow valuation ..................................................................................................... 5

2.1 Calculating WACC for Starbucks ........................................................................................... 5

2.2 Starbucks DCF assumptions and valuation ............................................................................. 6

2.3 Calculating WACC for Dunkin’ Donuts ................................................................................. 8

2.4 Dunkin’ Donuts DCF assumptions and valuation ................................................................... 9

3 Relative valuation ......................................................................................................................... 10

4 Final value estimate and recommendation ................................................................................... 13

5 Appendix ...................................................................................................................................... 15

6 References .................................................................................................................................... 17

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1 General overview

1.1 Industry outlooki

Globally the QSR (Quick Service Restaurant) sector generates over $570 billion in revenue. In the US

alone revenue was $200 billion in 2015, which shows material growth compared to the 1970’s revenue

of $6 billion. The industry is expected to have an annual growth of 2.5% for the next several years.

This is below the long term average, but better than the average of the last several years. QSR

consumers focus on taste, price and quality. QSR’s main focus is on consistency of experience,

affordability and speed. However, there is an increasing emphasis on providing more healthy choices

and socially responsible procurement of food. Among the fast food restaurants in the last couple of

decades, coffeehouse chains started to gain more market share and this led to a real coffee war as big

players like McDonald’s (entered in 2009) and Dunkin’ Donuts (around 2000) went after Starbucks.

As of today, on the US Market, Starbucks serves about one-third (29%) of total QSR, coffee shop, and

convenience store coffee cups. Dunkin’ Donuts has about 16.1% and McDonalds has about the same.

Research showed that that new entrants to the market and the 2008 recession led to a decreased market

share for Starbucks. Although coffee purchases were relatively recession proof, the amount of money

consumers were willing to spend per visit fell during the recession. This gave McDonald’s and Dunkin’

Donuts, which both cater to working- and middle-class households, a chance to enter the market with

lower priced, but still quality coffee products. Despite McDonald’s and Dunkin’ Donuts stealing

Starbucks’ market share, it’s technically impossible for them to become the industry leaders on the

long run. This is because the premium status that Starbucks maintains is likely to work to its advantage

as the economy improves. Starbucks has increased their lunch offerings to counteract McDonald’s and

Dunkin Donuts encroaching on their market share. In addition, going forward, the full impact of the

company’s 2012 purchase of La Boulange bakery should start showing benefits. Investors assume that

McDonald’s and Dunkin’ may be hurting each other and not Starbucks (this is an assumption made

based on the analysis of the market strategies of the three companies).

1.2 Starbucks

Starbucks Corporation, founded in 1985, is a premier roaster, marketer and retailer of more than 30

blends and single-origin premium coffees around world. The Company has more than 238,000

employees and operates about 24,000 retail stores in 70 countries around the world: the three major

segments are: Americas (United States, Canada, and Latin America), EMEA and China/Asia Pacific.ii

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In 2015 Starbucks realized revenues of $19.7 billion and a net income of $2.5billion. The core business

of the Company is purchasing, roasting and selling coffees together with tea and other beverages, as

well as merchandizing a variety of fresh food items through Company-operated stores or other

channels, such as licensed stores, grocery and national foodservice accounts. Together with the original

brand, the Company also owns the following trademarks: Teavana, Tazo, Seattle’s Best Coffee,

Evolution Fresh, La Boulange, Ethos and Torrefazione Italia Coffee.

In addition to primary services, Starbucks offers coffees, syrups and other products online, sells

packaged goods and supplies specific equipment, such as coffee brewers and espresso machines, to its

licensees. Starbucks’` business model includes both company-operated stores and traditional

franchising. The latter is used for Teavana and Seattle's Best Coffee, as well as Starbucks stores within

certain markets. Company-operated stores are mainly located in high-traffic locations: flexibility in

choosing the size and format of the stores allows the company to locate them in or near various settings,

including downtown, suburban retail centers and office buildings.

1.3 Dunkin’ Donuts

A leader in the quick service restaurant industry with over 19,000 points of distribution in 60 countries

all over the world, Dunkin’ Brands Group, Inc. (DNKN) uses a franchise business model that offers

coffee beverages, breakfast and ice cream through their two brands Dunkin’ Donuts and Baskin-

Robbins (ice cream). Originally established as a coffee shop in 1950 in Quincy, Massachusetts,

Dunkin’ Donuts was acquired by Allied Domecq in 1973 which acquired Baskin-Robbins in 1989.

The two brands were subsequently acquired by Bain Capital Partners, LLC, The Carlyle Group and

Thomas H. Lee Partners in 2005 and was renamed Dunkin’ Brands Group, Inc.iii They had their initial

public offering in July of 2011 where 20% of the company was offered for $422.8 million.iv

In 2015, the revenues for Dunkin’ Brands Group, Inc. totaled $810 million of which the Dunkin Donuts

brand brought in 79%.v Over 75% of this revenue comes from franchise fees, royalties and rental

locations. Other sources of revenue were sales from company owned stores and sales of ice cream. As

of December 26, 2015 Dunkin’ Brands Group carried $2,450 billion in long term debt and held $260

million in cash.vi

Number two in the coffee business behind Starbucks in terms of revenue and points of distribution,

Dunkin’ Donuts’ other close competitors are Tim Horton’s, Costa and McDonalds.vii Dunkin’ Donuts’

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competitive pricing and brand awareness are their main advantages over the competition. Dunkin’

Brands Group plans to continue their domestic and international growth especially in Asia and the

Middle East where their international presence is strongest.

2 Discounted Cash flow valuation

2.1 Calculating WACC for Starbucks

As a pre-requisite for DCF valuation, the discount rate, which is the WACC for the FCFF method, was

identified. To calculate the WACC for Starbucks the following assumptions were used:1

For the risk free rate a 10 year US T-bond was taken as reference at a rate of 1.87% (Yahoo

Finance), while the market risk premium (6.25%) was sourced from the Damodaran website.

Here the US market risk premium was used as the valuation assumes US as base country.

The country risk premium was calculated both by weighted average considering the number of

stores per region as well as the revenue share per region. The revenue was not available per

country, so the key countries were grouped into regions and then a weighted average

calculation was made of the country risks. Using the calculated risks at the regional level, the

weighted total country risk was calculated based on the stores and revenue share. There was

no material difference between the two calculations (.45% store based and .28% revenue

based), however a revenue based calculation was applied as it is a more adequate measure.

Similar Betas were found on the Morningstar, Reuters and Yahoo websites, and Yahoo’s Beta

(0.734) was applied.

In order to calculate the cost of debt, the best option would be to identify a SBUX bond which

matures in 10 years, however the closest bond will mature in 2023 at 3.85%. As an alternative

option, the FINRA website was consulted for company bond ratings on SBUX; also the credit

rating info of A- was obtained from the Starbucks website. The corporate spread over risk free

rate at 1.75% was sourced from the Damodaran website.

The debt market value was valued at $1,359m from the last five year average of the interest

bearing liabilities taken from the Starbucks’s balance sheets which were retrieved from the

Morningstar website.

1 Calculated on 23rd April 2016. Detailed assumptions can be found in the Appendix and in the supporting excel file.

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The equity market value was calculated at $62,952m by averaging shares for the past 5 years

found on the Morningstar website and multiplying that by the average share price from the past

two years. The share price, found through Yahoo Finance was taken only from the past two

years due to the recent material share price increase. A five year average would have

understated the reality.

The Marginal tax rate was used at 40% (from Damodaran), because there was no reference

found to the marginal tax rate in the Starbucks annual report.

The indexes were then inserted into the WACC formula and 6.65% was determined as outcome.

2.2 Starbucks DCF assumptions and valuation

In order to define the most applicable growth model for the company, two information sources were

taken into account. First the historical revenue growth parameters (derived from Income statements)

were consulted to help us understand recent sales growth profile, and to help to make reasonable

assumptions on future growth projections. This information was then combined with the lifecycle of

the company, and the timeframe expectation of when stable growth will be reached. In the case of

Starbucks, a historical 5 year CAGR is shown at 13.1% on revenue, while the stable growth can be set

at 3%, which is more or less equal to the GDP growth of a mature, developed economy like US. As a

consequence, a multiple stage growth model has been applied, spreading over 10 years - with a gradual

YoY decrease - when the company is estimated to reach stable growth. Analysts also endorse this

trend. Some expect a 12.3% growthviii for next year, yet others (Yahoo Finance or Morningstar) are

even more optimistic with forecasts for growth at 17.8-18.88% for the next 5 yearsix which may not

be justified.

Besides the growth trajectory, further assumptions have been derived from historical performance

associated with operating income, net capex and change in non-cash working capital as follows:2

The Operating income (EBIT * (1-T)) can be referenced as percentage to revenue, averaging

out yearly EBIT% (cleared from tax impact) in the most recent 5 years. Since there was a one-

time material hit in 2013 (driven by a lawsuit case lost against Kraft Foods), operating income

and corresponding tax rate were normalized so as not to distort the calculation. As a result,

10.79% will be used as reference for the valuation, which is still a conservative assumption as

the historical trend shows improvement in operational efficiency, hitting 12-13% in last 2 years.

2 Detailed assumptions can be found in the Appendix and in the supporting excel file.

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Data were taken from the Cash flow statements to calculate Net capex to revenue at average of

2.46% in last 5 years, which is lower than the industrial reference (per Damodaran: Global

(9.03%), US (4.19%.) for Restaurants), but can be accepted as basis.

In order to understand change in non-cash working capital, the net working capital was collated

from the Balance sheet. The average for Starbucks shows 7.82% net working capital to revenue,

which exceeds the industrial reference points (Global -0.47%, US 1.87%) indicating that

Starbucks should manage its debtor/creditor portfolio better.

Pulling all these data together, calculating the terminal value for 10+ years, and discounting the

amounts to identify the present value of the firm, the outcome is shown as follows:

in million $ Y0 Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10 Y10+

Growth rate 12,5% 12,5% 12,5% 10,0% 10,0% 8,0% 8,0% 5,5% 5,5% 5,5% 3,0%

Revenue

projections 19 163 21 558 24 253 27 285 30 013 33 015 35 656 38 508 40 626 42 861 45 218 46 575

Operating

income (EBIT

* (1-T)) 2 068 2 327 2 618 2 945 3 239 3 563 3 848 4 156 4 385 4 626 4 880 5 027

Net Capex 471 530 596 671 738 812 877 947 999 1 054 1 112 1 145

Net working

capital 1 498 1 685 1 896 2 133 2 346 2 581 2 787 3 010 3 176 3 350 3 535 3 641

ΔNWC 187 211 237 213 235 206 223 166 175 184 106

Free CF to

Firm 1 610 1 811 2 037 2 288 2 517 2 765 2 987 3 221 3 398 3 585 103 582

Present value 1 509 1 592 1 680 1 769 1 825 1 880 1 904 1 925 1 904 1 884 54 434

In line with the DCFF methodology, a few further steps were taken to calculate the intrinsic value of

equity and to understand the fair share price:

Value of the firm (m$) 72 305 Sum of Present value figures per above

Cash (+) 1 611 per submitted 2015 Balance Sheet (Total Cash value)

Debt (-) 2 348 interest bearing debt used for WACC (year 2015)

Calculated value of Equity (m$) 71 568

Number of shares (million) 1 496 Reference point: 27th September 2015, Annual report

Calculated Share price ($) 47,84

Share price on 25th September 2015 ($) 57,61

Variance -17,0%

The above calculation shows that at our reference point the Market rated the shares higher at

$57.61 than their fair estimated value of $47.84. In other words the conclusion is that the SBUX

shares are slightly overpriced.

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2.3 Calculating WACC for Dunkin’ Donuts

In order to process the WACC calculation for DNKN the following information was gathered:3

For the risk free rate a 10 year US T-bond was taken as reference at a rate of 1.87% (Yahoo

Finance), while the market risk premium (6.25%) was sourced from the Damodaran website.

Here the US market risk premium was used as the valuation assumes US as base country.

Although Dunkin Donuts has franchise operations in over 69 countries worldwide, the detailed

country level revenue information was not disclosed in the annual report. Nevertheless it was

identified that 82% of the revenue was generated in the US, while 74% of the international

business (which covers the remaining 18% of the total cake) was driven by 3 key geographical

areas: South Korea, Japan and the Middle East. In order to understand the DNKN Country risk

premium, a weighted average of the dominant country risk premiums was calculated utilizing

the Damodaran website to obtain country risk premium reference for the regions. The CRP

outcome used in the valuation is 0.23%.

The area of greatest concern was the Beta information. Searching through various websites,

this data was widely spread from 0.08 (Morningstar, Yahoo Finance) through 0.27 (Reuters,

FT) up to 0.7 (Nasdaq). A bottom up beta calculation was also made, supported by Damodaran

formulas, resulting 0.896(see Dunkin’ bottom up beta sheet for the detailed calculation). For

reference the Damodaran website was also consulted for US and Global industry beta on

Restaurant sector with results of 0.76 and 0.82, respectively. Having concerns regarding the

bottom up beta being the highest, the Global industry beta was used which is justified since

DNKN operates globally.

Since there was no DNKN bond issued and no credit rating information available, the cost of

debt is calculated using the synthetic rating approach (average interest cover ratio in past 5

years) which was matched to an A- rating. As a consequence 1.75% was added as corporate

spread (based on Damodaran) over the risk free rate, resulting in 3.62%, same as SBUX.

The debt market value is a 5 year average of interest bearing liabilities that were taken from

the Dunkin’ Donuts Balance Sheet (sourced from Morningstar) at value of $1,887m.

Equity market value ($4,077m) was calculated by taking the 5 year average of the number of

outstanding shares multiplied by the 4+ year average share price (IPO was in July 2011). Yahoo

3 Calculated on 24th April 2016, refined on 19th May 2016. Detailed assumptions can be found in the Appendix and in the supporting excel file.

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Finance provided the daily stock price info and the number of shares per year was taken from

the Morningstar website.

The Marginal tax rate was used at 40% (from Damodaran), because there was no reference

found to the marginal tax rate in the Dunkin’ Donuts Annual Report.

The correct formula was then used from these index points to obtain the WACC of 5.62%.

2.4 Dunkin’ Donuts DCF assumptions and valuation

Repeating the same exercise for Dunkin’ Donuts as for Starbucks, the most applicable growth model

was selected first. In the case of Dunkin’, a historical 5 year CAGR was 6.6% on revenue, while the

stable growth is still set at 3%, referencing the GDP growth of a mature, developed economy like US.

In this particular case the multiple stage growth model remains, however the spread is now reduced to

5 years - with gradual YoY decrease - when the company is estimated to reach stable growth. Some

analysts expect 5.2% growthx for next year, however some others (Yahoo Finance or Morningstar) are

very optimistic at 11.7-12.7% for the next 5 yearsxi which may not be justified.

Besides the growth trajectory, further assumptions shall be derived from historical performance

associated with operating income, net capex and change in non-cash working capital as follows:4

The Operating income (EBIT * (1-T)) can be referenced as percentage to revenue, averaging

out yearly EBIT% (cleared from tax impact) in recent 5 years. Figures are free from distortions,

hence normalization is not required. The average of 24.23% will be used as reference for the

valuation, which is more than twice as the same ratio for Starbucks.

Surprisingly Net capex to revenue calculation results a negative average of -3.12% in the last

5 years. This trend is not sustainable as there will be a minimum need to maintain and grow

business, even Dunkin’s structure is based more on license revenues than incomes from their

own shops. Considering this, the US industrial reference was used (per Damodaran: Global

(9.03%), US (4.19%) for Restaurants).

In order to understand change in non-cash working capital, the net working capital was collated

from the Balance sheet. The average for Starbucks shows 4.29% to revenue, which still exceeds

the industrial reference points (Global -0.47%, US 1.87%) indicating that Dunkin may manage

its debtor/creditor portfolio better than the industry average.

4 Detailed assumptions can be found in the Appendix and in the supporting excel file.

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Pulling all these data together, calculating the terminal value for 5+ years, and discounting the amounts

to identify the present value of the firm, the outcome is shown as follows:

in million $ Y0 Y1 Y2 Y3 Y4 Y5 Y5+

Growth rate 5,5% 5,0% 4,5% 4,0% 3,5% 3,0%

Revenue projections 811 856 898 939 976 1 011 1 041

Operating income (EBIT * (1-T)) 197 207 218 228 237 245 252

Net Capex 34 36 38 39 41 42 44

Net working capital 35 37 39 40 42 43 45

ΔNWC 2 2 2 2 1 1

Free CF to Firm 170 178 186 194 201 7 899

Present value 161 160 158 156 153 6 009

In line with the DCFF methodology, few further steps were taken to calculate the intrinsic value of

equity and to understand the fair share price:

Value of the firm (m$) 6 796 Sum of Present value figures per above

Cash (+) 260 per submitted 2015 Balance Sheet (Total Cash value)

Debt (-) 2 454 interest bearing debt used for WACC (year 2015)

Calculated value of Equity (m$) 4 602

Number of shares (million) 96 Reference point: 26th December 2015, Annual report

Calculated Share price ($) 47,94

Share price on 24th December 2015 ($) 42,09

Variance 13,9%

The above calculation shows that at our reference point the Market rated the shares lower at

$42.09 than their fair estimated value of $47.94. In other words the conclusion is that the DNKN

shares are slightly underpriced.

It is worth mentioning that outcome would be significantly different if the bottom up beta calculation

were used. As a consequence DNKN WACC would increase to 5.95%, and calculated value of Equity

would drop to $3,852m with fair share price value of $40.12. This would result a slightly overpriced

share with -4.7% variance.

3 Relative valuation

To make a relative valuation for Starbucks and Dunkin’ Donuts, the top quick service restaurants

(QSR) were chosen and we retrieved all the necessary inputs to find comparable values using the

multiples P/E and EV/EBITDA. Although the P/E ratio is a useful ratio for understanding the earning

power of a company, it does not tell the whole story regarding a company’s value. Thus, this relative

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valuation also includes the enterprise value to EBITDA as this metric is more comprehensive in terms

of defining the firm value. In addition to using these multiples, we have also included calculations for

growth, risk and other factors5 in relation to the top QSR to find comparable value for Starbucks and

Dunkin’ Donuts. A short industry overview6 is represented below.

Table 1. Industry distribution based on P/E and Revenue and Market Capitalization7:

To find the relative value of Starbucks, we started by analyzing the top three8 companies based on

market capitalization (MCD, YUM and CMG) and have calculated the mean and the median of both

the P/E ratio and EV/EBITDA. These calculations revealed that the mean9 P/E ratio for the top 3

companies is 27.13 and that the mean of the EV/EBITDA of the top 3 companies is 14.18. The

calculations based on the industry averages and data from companies` financials10 reveal an estimated

enterprise value of Starbucks at $69.565 billion and the estimated market capitalization at $74.797

billion dollars. To find the relative value of Dunkin’ Donuts, we have calculated the mean and median

for similarly sized QSR based on market capitalization which are listed number 4-8 on the top industry

list (BKW, DRI, PNRA, WEN, CBRL and EAT). Based on this sample, the mean values for P/E and

EV/EBITDA are 22.77 and 12.16, that yield the market capitalization and the enterprise value and of

$2.139 billion and $3.808 billion respectively. Descriptive data is represented in the Appendix.

Table 2. Results based on industry averages:

Companies 4-8 Mean 20.37 11.08

Median 20.59 11.52

Top 3 Companies Mean 27.13 14.18

Median 25.03 14.12

However, accounting only for the size of a firm requires rather strict implicit assumption: all the factors like

growth, risk and cash flows are similar for the comparable firms. To bypass this restriction we went further in

5 Due to A. Damodaran`s lecture, EV/EBITDA can be decomposed into EV/EBITDA=[1-t]/(WACC-g) + [Depr*tax/EBITDA/(WACC-g) - [CapEx/EBITDA]/(WACC-g) - [Change in NWC/EBITDA]/(WACC-g) 6 The list of the closest competitors was taken from the Reuters website: http://reuters.com/ 7 (Current) P/E Ratio = Share Price (end of Dec 2015)/Earnings per Share ended in Dec 2015; except for CBRL the Revenues are taken as of Dec

2015(TTM) 8 Table 2 is represented in the Appendix 9 In this case the mean and the median are very close because the distribution of the outliers is approximately symmetric 10 EBITDA and Earnings for SBUX are $4,907 mil and $2,757 mil as of FY2015 for SBUX; for DNKN the values are $343.6 mil and $105 mil respectively

MCDYUMCMG

DRI

PNRAWENCBRL

EAT

SBUX

DNKN

0

10

20

30

40

50

$0 $30 $60 $90 $120

P/E

Rat

io

RevenueBillion US Dollars

Competitive analysis

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analyzing the industry. We decomposed each multiple into its most significant determinants11: growth and risk

for the P/E ratio and growth, risk, tax rate (effective), ROC and WACC for the EV/EBITDA. Evaluating each

firm using this approach provides us with a much more precise measure of the actual worth.

Table 3. Decomposition of the multiples

Ticker Earnings Growth12 Tax (effective) ROIC13 WACC D/E (book) 14 Beta Stock relative S.D.

MCD 14.05% 32.76% 19.47 2.70 2.98 0.51 5.40%

YUM 10.98% 29.07% 26.24 7.30 5.46 0.72 8.95%

CMG 14.76% 38.20% 23.80 5.61 1.31 0.61 17.45%

DRI 14.15% 21.02% 13.52 5.55 3.06 0.51 14.94%

PNRA 15.21% 36.50% 22.12 2.96 1.93 0.74 7.47%

WEN 15.05% 34.62% 4.01 5.73 2.89 0.86 14.31%

CBRL 9.07% 30.41% 16.34 8.95 3.42 0.48 17.70%

EAT 10.32% 29.55% 17.68 8.17 10.34 0.43 12.15%

SBUX 18.23% 31.93% 23.92 6.65 2.01 0.73 14.96%

DNKN 14.05% 37.36% 7.91 5.62 7.55 0.82 7.71%

Note: Stock S.D. is a stock relative standard deviation over 2013-2015 period.

The calculations suggest that Starbucks company`s operations have two unique features in comparison

to the peer group: on the one hand, it has extremely high growth rates, volatile stock price and high

WACC value, that suggests that this company is at its high growth stage; on the other, it is currently

the second largest player in the market and it has one of the highest return on capital values. On this

basis it is reasonable to assume that the closest proxies for Starbucks are Chipotle Mexican Grill

(CMG) to reflect the potential of a high growth and risk company and McDonalds to account for the

influence of the size and a lower effective tax rate. Taking a simple average of the multiples for these

two companies (28.18 for P/E and 14.9 for EV/EBITDA) and multiplying it by company`s earnings

and EBITDA yield the estimate for the enterprise value of SBUX is $73,089 billion, whereas the P/E

ratio provides us with an estimated market capitalization of $77,692 billion .

As a best comparable for Dunkin’ Donuts Panera company was chosen. These two firms are very

similar in all respects: they have almost identical effective tax rate, risk (both in terms of stock price

volatility and beta), expected growth and cost of capital. Although there are still a few factors that are

different for the two firms, leverage and ROIC, it is expected that their effects on both multiples will

approximately offset one another. Based on Panera`s multiples (33.5 for P/E and 13.25 for

EBIT/EBITDA) we obtained the estimated market capitalization of $3,520 billion and the enterprise

value of $4,553 billion for Dunkin’ Donuts.

11 Unless there is a reference to the outside source, the data is taken from companies` financials or is calculated by our team 12 Expected growth in Earnings (Net Income), projections are taken from the NASDAQ official website http://nasdaq.com/ 13 ROC and WACC calculations (for SBUX and DNKN we use own calculations, for DNKN we use bot. up beta) are taken from http://gurufocus.com/ 14 D/E and Betas are taken from the Morningstar: http://morningstar.com/

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The final estimations on the relative valuation approach for Starbucks and Dunkin Donuts, together

with actual market capitalization as of December 2015 are represented below15.

Ticker DNKN SBUX

Multiple base PE based EV/EBITDA based PE based EV/EBITDA based

Actual equity value16 $3,945.50 $84,413.00

Estimated equity value, industry average approach $2,138.64 $2,266.29 $74,797.41 $68,826.10

Estimated equity value, decomposition approach $3,519.60 $3,138.48 $77,692.00 $72,350.97

% deviation, industry average approach -46% -43% -11% -18%

% deviation, decomposition approach -11% -20% -8% -14%

Calculated share price range (decomposition approach) $33.67-$37.46 $49.55 - $53

Based on the relative value findings we suggest that both companies are slightly overvalued as of

December 2015. It is also important to notice the difference in two methodologies: we suggest that the

decomposition approach captures the real value of both companies; it results in an estimated price that

is slightly lower than the actual one. The results for Dunkin Donuts do slightly differ: relative valuation

suggests that it is also slightly overestimated, whereas DCF estimation suggests that it is slightly

underpriced. However, deviations in both directions for this firm are not crucial and we suggest that it

just reflects the deviation around the mean, and the company is approximately fair priced.

4 Final value estimate and recommendation

In conclusion, the valuation analysis for Starbucks for the end of the financial period (September 27,

2015) from the DCF reveals that Starbucks share price is slightly overstated (DCF valuation $47.84

while end of period price was $57.61). For the relative valuation, Starbucks was similarly found to be

overpriced in comparison to both industry and the peer firms which reflected a deviation in value

ranging from $49.55 to $53 depending on the multiples that were applied. In both instances we can

conclude that Starbucks was slightly overvalued at the end of the reporting period and would not have

been a good buy at that time. It is interesting to note that in the past 8 months, the market capitalization

for Starbucks has decreased to $80,013 million today which would support our conclusion that the

company was overvalued at the end of their financial year 2015. The best recommendation for

Starbucks is that the stock should be held for now and additional investment decisions should be

deferred by a quarter or two when the trends can be reassessed.

The valuation analysis for Dunkin’ Donuts is not as straightforward becasue the two analysis methods

resulted in different outcomes. The DCF valuation indicates that the fair estimated valuation of the

15 Enterprise value is adjusted by total debt, cash and equivalents and minority interest; total amount of the adjustments are $2.192 billion and $0.738 billion dollars for DNKN and SBUX respectively 16 Data on actual market capitalization is taken from the Morningstar website: morningstar.com

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company is higher ($47.94) than the current treatment in the market ($42.09). For the relative

valuation, Dunkin’ Donuts was found to be slightly overvalued based on Panera’s multiples, the

company that shares similar to Dunkin Donuts growth, risk and other influencing factors, with an

estimated market capitalization of $3,520 billion whereas the actual market capitalization was $3,945

billion at the end of 2015, that yields a price per share range from $37.46 to $33.67. Further analysis

of the company`s price trend reveals that it experienced a significant drop during Sep 2015 – March

2016, however, during March-May 2016 it was traded at approximately same market price as in Fall

2015 (at about $48).

In comparing the two companies, there is a higher probability that Dunkin’ Donuts price is fairly

assessed by the market (or even undervalued) and therefore this should be the best investment option.

Similarly, the market capitalization for Dunkin’ Donuts has gone up some however it is currently at

the same level ($3,993 million) as at the end of year 2015 which would support the conclusion that it

is fairly priced and would be a better investment in comparison to Starbucks. However, Starbucks does

have more growth potential than Dunkin’ Donuts. So despite the fact that Starbucks is overvalued at

this time, it should be reassessed as a good investment option in the coming quarters because of its

extremely high revenue,earnings growth rates and positive expectations about company`s future in

general.

15

5 Appendix

Table 1. Starbucks WACC – detailed (Reference point 27th September 2015)

Index ref Index name Value Proxy Source

r(f) risk free rate 1,87% 10 years US T-bond Yahoo Finance website

MRP market risk

premium 6,25% US market risk premium Damodaran website

CRP country risk

premium 0,28%

weighted average of country risks, see

detailed tab

Starbuck annual report for global sales mix

Damodaran website for country risks

β beta 0,734 similar betas: Morningstar (0,73) and

Reuters (0,76), Yahoo is applied

Yahoo Finance website

Morningstar website

Reuters website

r(d) cost of debt 3,62%

S&P credit rating: A-, corporate spread:

1,75% over risk free rate (applied)

closest maturity of SBUX bond (in

2023): 3,85%

FINRA website (for company bonds)

credit rating from Starbucks website

corporate spreads from Damodaran website

D debt market value

(in m USD) 1 359

5 year average interest bearing liabilities

from Starbucks balance sheets Morningstar website

E equity market

value (in mUSD) 62 952

avg. # of shares (5 years) * avg. share

price (2 years only, see detailed tab)

Morningstar website (# of shares per year)

Yahoo Finance (price per year)

T marginal tax rate 40% US marginal tax rate

no special reference in annual report Damodaran website

Table 2. Dunkin Donuts WACC – detailed (Reference point 26th December 2015)

Index ref Index name Value Proxy Source

r(f) risk free rate 1,87% 10 years US T-bond Yahoo Finance website

MRP market risk

premium 6,25% US market risk premium Damodaran website

CRP country risk

premium 0,23%

weighted average of country risks, see

detailed tab

Dunkin' Donuts annual report for global sales mix

Damodaran website for country risks

β beta 0,820

beta info is widely spread,

Damodaran Restaurant industry beta for

US: 0.76, for Global: 0,82

bottom up calculation: 0.896 (Global

beta is used)

Yahoo Finance website

Morningstar website

Reuters website

Nasdaq website

Financial Times website

Damodaran website

r(d) cost of debt 3,62%

using interest cover ratio (see tab)

corporate spread: 1,75% over risk free

rate (applied)

no DNKN bond issued, no credit rating

info available

Morningstar (for company bonds and interest cover

ratio)

corporate spreads from Damodaran website

D debt market value

(in m USD) 1 887

5 year average interest bearing liabilities

from Dunkin Donuts balance sheets Morningstar website

E equity market

value (in mUSD) 4 077

avg. # of shares (5 years) * avg. share

price (4+ years, see detailed tab)

Morningstar website (# of shares per year)

Yahoo Finance (price per year)

T marginal tax rate 40% US marginal tax rate

no special reference in annual report Damodaran website

16

Table 3. Starbucks DCF reference calculations

References 2011-09

2012-

09

2013-

09

2014-

09

2015-

09 AVG

WACC (SBUX) 6,65% calculated on 23rd April 2016 for interim report

Revenue 11 700 13 300 14 892 16 448 19 163 per submitted 2015 Income statement

Operating Income

(normalized) 1 525 1 787 2 275 3 081 3 601 per submitted 2015 Income statement

Operating income % 13,0% 13,4% 15,3% 18,7% 18,8% 15,9%

conservative assumption as last 2 years shows

improved productivity

Tax rate% (normalized) 31,1% 32,7% 31,9% 34,6% 29,3% 31,9% per submitted 2015 Income statement

EBIT (1-T) 1 051 1 202 1 549 2 016 2 546

EBIT (1-T) % 9,0% 9,0% 10,4% 12,3% 13,3% 10,79%

conservative assumption as last 2 years shows

improved productivity

Capex investments 532 856 1 151 1 161 1 304 per submitted 2015 Cash Flow statement

Depreciation 550 581 656 748 934 per submitted 2015 Cash Flow statement

Net capex -18 275 495 413 370 388

Net capex to revenue 0% 2,1% 3,3% 2,5% 1,9% 2,46%

Damodaran Global net capex/revenue rate: 9,03%,

US: 4,19% for restaurant/dining sector

Current assets 1 352 1 728 1 672 1 722 2 025 1 700 per submitted 2015 Balance Sheet (Inventory + AR)

Current liabilities 540 398 492 534 684 530 per submitted 2015 Balance Sheet (AP only)

Non-cash Net WC 812 1 330 1 180 1 188 1 341 1 170

net WC to revenue 6,9% 10,0% 7,9% 7,2% 7,0% 7,82%

Damodaran Global nwc/revenue rate: -0,47%,

US: 1,87% for restaurant/dining sector

Table 4. Dunkin Donuts DCF reference calculations

References

2011-

12

2012-

12

2013-

12

2014-

12

2015-

12 AVG

WACC (DNKN) 5,62% revised for the final report

Revenue 628 658 714 749 811 per submitted 2015 Income statement

Operating Income 209 239 305 331 318 per submitted 2015 Income statement

Operating income % 33,3% 36,3% 42,7% 44,2% 39,2% 39,1%

Tax rate% 47,8% 33,3% 33,0% 31,3% 47,5% 38,6% per submitted 2015 Income statement

EBIT (1-T) 109 159 204 228 167

EBIT (1-T) % 17,4% 24,2% 28,6% 30,4% 20,6% 24,23%

Capex investments 19 22 31 24 30 per submitted 2015 Cash Flow statement

Depreciation 53 56 49 46 45 per submitted 2015 Cash Flow statement

Net capex -34 -34 -18 -22 -15 -22

Net capex to revenue -5% -5,2% -2,5% -2,9% -1,8% -3,12%

Damodaran Global net capex/revenue rate: 9,03%,

US: 4,19% for restaurant/dining sector

Current assets 37 32 47 56 53 45

per submitted 2015 Balance Sheet (Inventory +

AR)

Current liabilities 10 16 12 14 19 14 per submitted 2015 Balance Sheet (AP only)

Non-cash Net WC 27 16 35 42 34 31

net WC to revenue 4,3% 2,4% 4,9% 5,6% 4,2% 4,29%

Damodaran Global nwc/revenue rate: -0,47%,

US: 1,87% for restaurant/dining sector

17

Table 5. List of comparable companies. All numbers are in millions except for per share data and

ratio.

Company Ticker PE Ratio EV/EBITDA Market Capitalization Revenue

McDonalds MCD 24.56 14.12 $ 107,129.00 $ 25,413.00

Yum! Brands, Inc. YUM 25.03 12.74 $ 30,681.00 $ 13,105.00

Chipotle Mexican Grill Inc CMG 31.8 15.67 $ 14,674.00 $ 4,501.00

Darden Restaurants Inc DRI 10.83 12.17 $ 7,434.00 $ 6,905.00

Panera Bread Co PNRA 33.52 13.25 $ 4,817.00 $ 2,682.00

The Wendy's Co WEN 20.59 10.33 $ 2,945.00 $ 1,870.00

Cracker Barrel Old Country Store CBRL 22.28 11.52 $ 3,642.00 $ 2,862.00

Brinker International, Inc. EAT 14.62 8.14 $ 3,493.00 $ 3,100.00

Starbucks Corp (actual) SBUX $ 84,413.00 $ 19,734.00

Dunkin' Brands Group Inc (actual) DNKN $ 3,945.50 $ 810.90

6 References

i https://www.franchisehelp.com/industry-reports/fast-food-industry-report/

http://www.investopedia.com/articles/markets/101315/who-are-starbucks-main-competitors.asp

http://time.com/money/3028578/dunkin-donuts-mcdonalds-starbucks-coffee-wars/

http://www.fastcocreate.com/3034572/coffee-week/dunkin-donuts-and-starbucks-a-tale-of-two-coffee-

marketing-giants

https://inevitablesteps.com/company-analysis/starbucks-competitors/

https://www.qsrmagazine.com/reports/top-50-breakdown-market-segments

ii Based on the Company Annual Report for FY2015

iii Dunkin Brands Group Annual Report 2015, p.1. Retrieved from:

http://files.shareholder.com/downloads/ABEA-68SCR9/1924588177x0x883107/32BF1764-3E53-45CF-9824-

D8753F797D37/DNKN_Annual_Report_Final_.PDF

iv Retrieved from: http://www.nasdaq.com/markets/ipos/company/dunkin-brands-group-inc-703168-67014

v Dunkin’ Brands Group Annual Report 2015, p.56

vi Dunkin Brands Group Annual Report, 2015, p. 45 and p. 48

vii Sicoli, Carlo. “The Five Largest Coffee Shop Chains on Earth” The Richest, February 9, 2014

viii http://investorplace.com/2016/02/buy-not-dunkin-donuts-starbucks/#.Vz8q5Gxf34h

ix http://financials.morningstar.com/valuation/earnings-estimates.html?t=SBUX&region=usa&culture=en-US

and http://finance.yahoo.com/q/ae?s=SBUX+Analyst+Estimates

x http://investorplace.com/2016/02/buy-not-dunkin-donuts-starbucks/#.Vz8q5Gxf34h

xi http://financials.morningstar.com/valuation/earnings-estimates.html?t=DNKN and

http://finance.yahoo.com/q/ae?s=DNKN+Analyst+Estimates