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Starbucks, awash in cash, borrows for buybacks

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By Charles Mead
Bloomberg News
NEW YORK -- Starbucks, which generates more free cash relative to its debt than any U.S. restaurant chain, may more than double borrowings to reward shareholders without hurting its credit.
The world's largest coffee-shop operator plans to add $750 million of debt to the $550 million of bonds it has outstanding after three years of revenue growth that's outpaced the Standard & Poor's 500 index average. With a debt-to-equity ratio of 9.6, the lowest since 2006, Starbucks could borrow as much as $1 billion without "materially affecting" its credit profile, according to Morningstar, which expects the company to repurchase shares with the proceeds.
Starbucks is adding debt at a time when Chief Executive Officer Howard Schultz's push into food such as zesty chicken and black bean salad bowls is lifting sales and profits, enriching shareholders and bondholders. Even with the added liabilities, the coffee chain with an A- credit rating from S&P would still be safer than about 90 percent of indebted S&P 500 companies, based on its debt-to-equity ratio.
"They're happy with that A-rating, but they do recognize that they do have some room to lever up," Joscelyn Mackay, an analyst at Morningstar in Chicago, said in a telephone interview. "This is a company where their balance sheet has gotten away from them in a positive sense, in that they've continued to grow and earnings have continued to grow, and they haven't kept pace with it."
Free-cash flow, money available to be reinvested in a company, to retire debt and to pay dividends or repurchase stock, will grow 50 percent in the year ending Sept. 30 and 14 percent more in the following 12 months to $1.54 billion, according to a Bloomberg survey of equity analysts.
The new borrowings may bring Starbucks's debt-to-equity ratio to about 23 percent, less than half the average level for S&P 500 companies ranked A- or higher that cater to discretionary consumer spending.
Starbucks last sold bonds in 2007, issuing 6.25 percent securities due August 2017 to yield 165 basis points more than Treasuries. New 10-year notes may pay a coupon closer to 3.5 percent, according to data compiled by Bloomberg based on the average yield for the $39 billion of similar-maturity bonds issued this year by non-financial companies with credit ratings in the A tier.
Moody's Investors Service ranks Starbucks Baa2, two levels below S&P.
"We've long recognized that there's opportunity with an extremely conservative balance sheet to bring a bit of debt on," Chief Financial Officer Troy Alstead said on a July 25 conference call with analysts and investors to discuss third- quarter earnings. He said leverage probably would be "targeted around" the company's current A- grade from S&P.
Jim Olson, a company spokesman, declined to comment beyond the conference call and regulatory filings on financing plans.
Of the 11 consumer-discretionary companies in the S&P 500 with market values bigger than $50 billion, Starbucks has the least debt, trailing the borrowing levels of businesses including McDonald's and Nike. Those two have sold a combined $1.5 billion of dollar-denominated bonds this year, Bloomberg data show.
Starbucks could add that amount of debt "and still have credit metrics and growth prospects that are better than McDonald's," which is ranked A by S&P, said Joel Levington, managing director of corporate credit research at Brookfield Investment Management in New York. "While no bondholder is fond of seeing a name add leverage for share repurchases, which may be one use of cash for Starbucks, they have also made some smart acquisitions, and the new issue will add liquidity."
The company's 6.25 percent notes yield about 1.96 percent, 41 basis points more than the yield on $650 million of 5.8 percent notes due October 2017 issued by McDonald's, whose debt- to-equity ratio of 84 percent is more than eight times the leverage at Starbucks. The spread between the two bond yields has averaged about 38 basis points, or 0.38 percentage point, over the past year.
Starbucks's revenue increased 11.5 percent in the 12 months ended June 30, exceeding expansion at McDonald's, the world's largest restaurant chain, by more than nine times.
The company is "in the early innings of a global expansion that may last for decades" and is poised to benefit from lower coffee costs and higher-margin food offerings, Goldman Sachs equity analysts led by Michael Kelter said in a July 26 report. Schultz has sought to boost U.S. sales by adding juice, baked goods and tea, and he spent $626 million to buy Teavana in January after dropping the word "coffee" from the Starbucks logo in 2011.
Sales from its China and Asia Pacific region surged 26 percent from a year earlier to $661 million in the three quarters ended June 30, and now account for about 6 percent of total revenue, up from 5.3 percent in the period ending July 1, 2012, according to a July 30 regulatory filing.
Adopting a more aggressive capital structure would be "solidly accretive" to earnings per share, the Goldman Sachs analysts wrote in a June 13 report, before Starbucks exceeded the average of 28 estimates with third-quarter net income of 55 cents a share. The stock has gained 38 percent this year, compared with a 20 percent increase for the S&P 500.
The company faces the risk that a dispute with Kraft Foods may result in a cash drain. Starbucks canceled a distribution agreement with Kraft in 2011, accusing the Northfield, Ill.-based grocery business of breaching a contract linked to the promotion of packaged coffee in grocery and warehouse club stores, according to the July 30 filing.
Kraft has claimed damages of as much as $2.9 billion in arbitration, and while Starbucks believes an "unfavorable outcome" is unlikely, losses that can't be reasonably estimated are still a possibility, according to the filing, which forecasts a decision in the second half of fiscal 2013.
"If there is some high potential liability that they have to pay Kraft, we anticipate that they may issue debt," Mariola Borysiak, an analyst at S&P in New York, said in a telephone interview. "Credit metrics are strong for the rating, but we don't know what the potential outcome of the Kraft litigation could be."
With current debt adjusted to reflect lease payments at about the same level at its $2.7 billion of earnings before interest, taxes, depreciation and amortization, Starbucks has room to increase borrowings by a similar amount before endangering its credit grade, Borysiak said.
"International growth remains strong," Borysiak said. "There could be some additional debt issued in the future," beyond the $750 million currently planned, she said.



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