Starbucks: Two Years of Missteps and an Overdue Admission

Of course Starbucks (SBUX) slipped in an SEC filing and did not actually say it out loud. There have been few companies that I have covered that have been either as clueless as to their business environment or as dishonest about it with shareholders as Starbucks has over the past almost two years.

Back in Feb. 2007, the CEO Jim Donald claimed that McDonald's' (MCD) then new entry into premium coffee would be a benefit to Starbucks as McDonald's' customers would then trade up to him. At the time I detailed the folly of this statement and said "I advise any potential new shareholders to avoid shares...at $34."

Less than a month later, then retired founder and former CEO Howard Schultz penned a memo saying, without naming, that "competition has created awareness" of themselves, the company had "got away from its roots" and that it was affecting results.

In May 2007, with milk prices soaring and flimsy earnings out, I detailed how dairy prices would hurt the company despite the fact management denied it would affect earnings and CEO Donald said "we do not consider the competition" when asked about McDonald's. Um....can't really even add to that...Shares at $28.

Only weeks later Starbucks switched from whole milk to 2% in all drinks for "customer service" reasons and at the time I said it was all about milk prices, then at decade highs... (2% is cheaper than whole milk).

Fast forward a month, Starbucks issues a profit warning and says "rising dairy costs are a challenge".....duh.

Then came the announcement of the near $6 salad. At the time I commented that for a company that Schultz had lamented "got away from its roots" in his famous memo, nothing it had done since then was a return to them.

Then, just in case you weren't convinced the ship wasn't drifting listlessly, in late July facing declining store traffic and an increasingly cash strapped consumer, Starbucks did what? Raised prices...

Less than a week later Starbucks admits increased prices leads to less store visits by customers....yet they maintain price levels...

Finally in September Starbucks admits "dairy prices will be a negative into 2008"...Shares now priced at $27.

In Jan. 2008 Schultz finally did what I begged him to do for almost a year, and fired Donald.

In Feb. 2008 the company admitted what I hope anyone who has read the blog already knew, the coming year would be a poor one. Shares priced at $18.

In March things got weird. Starbucks decided that it was going to start a social site so Starbucks fans can go online and talk about it.....more of Schultz "going back to the roots" of the company?

In May we find out the fired CEO Jim Donald cannot work "for the competition"....McDonald's..but, we thought they weren't?

In July Starbucks started playing games with the earnings release to hide how bad results really were. Shares priced at $14.

In August Schultz gave an interview in which he called the coffee at McDonald's and Dunkin Donuts "swill", said he won't "dilute the brand" by "going down the fast food road" and then does just that only days later with the "$2 after 2" promotion. Shares priced at $14

Current day. I have stopped following Starbucks as closely as before because with the stock at $9 vs the $34 it was at when I told folks to run from it, I hope the story is clear for all to see. But, I could not let this one go by.

From the WSJ:

The filing to the Securities and Exchange Commission sheds light on how much of a threat new competition is to Starbucks, as McDonald's Corp. and other restaurants add espresso drinks and more elaborate beverages. In the filing, Starbucks says that, in the U.S., "the continued focus by one or more large competitors in the quick-service restaurant sector on selling high-quality specialty coffee beverages at a low cost has attracted Starbucks customers and could, if the numbers become large enough, adversely affect the company's sales and results of operations."

Not bad... It took 22 months for the company to either recognize or admit it... Just terrible...

Disclosure: Long MCD

Comments

[Ames Tiedeman:]

This is the most classic case of how a company can expand beyond what a given market can absorb. You simply do not need a coffee shop on every corner.

2008 Nov 25 08:06 AM

[Jeff B.:]

They say every dog has his day, and i guess Starbucks had a longer run than most. Perhaps there are too many stores, and perhaps in a down economy people don't want to buy $4 lattes. However, IMHO Starbucks is still the only really good place to get a consistently great cup of coffee in any town, city, country. I am sorry, but DD just doesn't cut it for me. Tastes like watered down potting soil. So maybe Starbucks was overvalued for a long while, but in my view it's really undervalued now. I hope i am right.

2008 Nov 25 10:59 AM

[Ken G:]

I totally agree with Jeff. Yes, Starbucks will have difficulty in this economy, as the majority of merchants and retailers will. However, you cannot find better espresso, cappucino, lattes, or coffee anywhere else. I have tried local places and their espresso does not compare. More importantly starbucks trains their staff to function like a well oiled machine taking very complicated drink orders. Mcdonalds and Dunkin Donuts either give you tons of cream and sugar or none at all. I used to think Starbucks was a big evil corporation, but since reading Shultz's book they are one of the few companies out there with a social conscience.

2008 Nov 25 02:05 PM

[swagvalance:]

I have to believe Ken G is being disingenuous here when he writes, "you cannot find better espresso, cappucino, lattes, or coffee anywhere else". Maybe compared to Starbucks' fast-food bretheren, but therein lies the rub: that is precisely what they've become.

The quality mantra has been Starbucks party line for decades. Problem is, and Schultz has even admitted it, the company sold out its market leadership in quality to chase after store growth at all costs. And that meant spending the past decade automating everything they did well to use push-button vending machine-style espresso machines, enabling them to hire lesser and lesser skilled baristas to keep the doors open on these exploding number of shops, etc. Meanwhile, the competition has eaten away all their credibility at the quality end: Peet's, Tully's, Caribou, and an armada of new independents that run circles around all of the big chains.

The result? There are annual barista competitions all over the world, and yet not a single Starbucks barista can even compete -- because their dumbed-down equipment and dumbed-down hiring standards to operate it prevent it from even being possible.

Starbucks cannot trumpet the "quality" line anymore without sounding as hollow as their investor relations materials.

2008 Nov 25 03:22 PM

[forty-four:]

Oh please Todd. It doesn't take Nostradamus to make these "predictions" when real estate/oil/food prices are skyrocketing and banks are lending to anyone that is alive. You know as well as anyone else that uses their brain a little that this all had to end sometime...Basic laws of supply and demand.
A serious coffee person does not go to McDonald's, unless they are short on cash or rushing to take the kids somewhere.
The name is Dunkin' Donuts for a reason. Coffee goes with the donut, but they won't dare change the name to Dunkin' Coffee.
Starbucks quickly expanded to discourage any ideas some other coffee place had of expanding and sharing the wealth. Otherwise, they would have some serious competition for their customers.
I can't wait for your article in the next year or two, when the economy is on the mend that says "Advise buy Starbucks now because they are now doing what I have been saying they should do."

2008 Nov 25 05:16 PM

[User 190720:]

the stock is cheap and should recover but will take time. Its depended on the economy. I just recently purchase a Starbucks gold card for $25, thought it was a good deal, since I go to Starbucks all the time. Found out that $25 is membership fee and I have to add more dollars to buy drinks. Now this $25 is a really stupid idea, considering that not even credit cards charge a membership fee. Instead, Starbucks should let people charge $25 and then this money shold go towards the purchase of stuff in Starbucks and yes they should still give discounts to loyal customers

2008 Nov 26 12:02 AM

[delcape:]

This from one who has owned 'BUX for over 14 yrs;

Howard Schultz is a marketing wizard. He loves his baby.

Maybe not for a few years, but Starbucks WILL rise again.

I intend to BUY, no hurry, and I have grandchildren who will be thrilled that this co. is part of the family portfolio. After enjoying two 2 for 1 splits, and selling some at $38 a few years ago, I'm playing with "house money"... BUY ! at anything in single digits - it WILL come around again down the road.

2008 Nov 26 08:07 PM