Starbucks's Uphill Battle

2009 looks to be another difficult one for Starbucks (SBUX). Last year, in the face of increased input costs and declining sales, the company took the drastic step of not only slowing its torrid growth in stores, but actually closing some of the underperforming and high cost ones. Now, with the economic outlook increasingly bleak, many investors are wondering how susceptible the company is to declines in discretionary spending, and many have reduced their expectations for Starbucks’ performance.

Nonetheless, at under $12/shares, the stock would appear at first glance to be a great opportunity. Starbucks is, after all, one of the great growth stories of the last two decades.

But to support a stock price of $11.77, Starbucks will need to take continued cost cutting measures, all while finding a way to keep sales growth positive. This will be tough. The current stock price implies slow revenue growth that ramps up in subsequent years. The company can get away with the mere 1% growth in 2009 that many are expecting, but this must increase markedly two and three years out, else at $11.77 the stock is indeed too expensive. Thus, although the cost-cutting measures measures and store closings ought to have an immediate impact on the bottom line, but there is still much growth implicit in the price of Starbucks’ stock.

The accompanying RBP Company Snapshot (See Starbucks’ current RBP snapshot) shows that, to support the current stock price, this revenue growth will need to return to the more historically consistent levels of 6.5% and 9.9% in 2010 and 2011 after a sluggish 2009. This implies that after shuttering, net, 254 U.S. stores in 2009, the company will need to add about 250 and 350 stores in 2010 and 2011. What is more, Starbucks will need to continue to open new stores internationally throughout the current year and beyond. These are the Required Business Performance components – the level at which the company must perform in order to meet its Required Business Performance.

When analyzed from this perspective, Starbucks stock may not seem like such a good investment. Sure, the stock is down nearly 70% from its high in 2007, but if this market has shown us anything in the last six months, it is that the mantra “How much cheaper can it get?” can make the rich man poor and the poor man broke. If the current economic climate does not improve soon, it seems unlikely that a company selling $4 cups of coffee will be able to successfully expand an already ubiquitous business.

Said differently, Starbucks is still priced like a growth stock. But growth is no longer management’s primary concern.

The Company RBP Snapshot also shows that the RBP Probability of Starbucks is currenlty only 75%, compared to a sector median of nearly 88%. This also makes the coompany appear to be a very weak investment relative to alternatives.