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By Howard Bailey

Some people just rub us the wrong way – Howard Schultz, the CEO of Starbucks (SBUX), for instance – and even a modest level of antipathy can cloud one’s judgment. In other words, I’ve been wrong in assessing the coffee retailer’s prospects and investment potential in recent years, and it’s time to fess up.

Whether that means that Starbucks is a good buy now is another matter. But it is certainly a far more impressive company than I’ve given it credit for. Let me hasten to add that I haven’t been in denial about the stock’s lovely ascent, or the company’s remarkable comeback since Schultz retook the CEO’s job. Rather, I’ve questioned its valuation relative to other stocks, like McDonald’s (MCD), and questioned whether Schultz is sufficiently focused on the main business, selling coffee beverages, to extend the comeback sustainably. In doing so, I’ve failed to appreciate just how fabulous an operation Starbucks possesses.

SBUX Chart
(Click to enlarge)

SBUX data by YCharts

I come to this new point of view in an unusual way:

When Starbucks reported fiscal first quarter results, for the period ended December 29, 2013, its overall same-store sales growth of 5% slightly disappointed Wall Street. And Schultz, who is given to overstatement – bombast, even -- was quoted in the Wall Street Journal as offering the following explanation:

"2013 was the first holiday that many traditional retailers saw in-store foot traffic give way to online shopping in a very big way. Customers watched, waited, compared prices and then bought the brands and products they wanted online -- frequently using a mobile device to do so."

(Staying at home, of course, meant these shoppers didn’t stop in for a latte.)

Schultz went on, the Journal reported, to add, “Starbucks is well positioned to benefit from the shift thanks to its investment in mobile-payment options and electronic gift cards.”

Typical Schultz bluster. Nothing happens at Starbucks without it being part of an amazing global trend. One the company is at the middle of. Of course, 2013 was hardly the first Christmas that online retailers lured shoppers away from malls. And Starbucks’ investment in online payments technology (far-sighted though it may be) is tiny compared to its overall business. And even Schultz hasn’t figured out how to sell a latte without the customer coming to his store (pre-made mixes aside). Why can’t the guy just say we missed our number and we’re going to do better?

If you doubt Schultz’s self-absorption, read his second self-flattering memoir. And if you think he’s as altruistic as he suggests, try to make sense of this personal airplane reimbursement deal. It’s stuff that like that makes you want to doubt the man.

In that mindset, in recent days, I started reading: re-reading the latest 10-K, an array of financial journalism on the company in recent months, an investor presentation, the disclosure on the most recent results, and more. But rather than collect more ammo for my anti-Starbucks bias, what I found was evidence of surprising and continuing strength in the business. And I ended up thinking Starbucks is quite exceptional.

Not necessarily for the reasons Schultz would cite. The kind of stuff that impressed me, rather, was:

--Gradually rising transaction per employee work hour in company-owned U.S. stores, hitting 11.7 last fiscal year vs. 11.3 in fiscal 2011. That’s a small, but impressive improvement this late into an operational turnaround.

--A ratio in the U.S. of roughly 16 in-store employees (revenue creators), or a total of 129,000, for every one worker involved in support functions, or a total of 8,000. That’s cost discipline and leverage.

--A mere $205.8 million spent in fiscal 2013 on advertising, considering its roughly 20,000 stores worldwide (about half company-owned and half licensed) vs. $787.5 million on ads at McDonald’s in 2012 (the latest full year reported), across the burger chain’s roughly 35,000 stores (more franchised than owned). That’s brand power.

SBUX Revenue Per Employee (Annual) Chart
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SBUX Revenue Per Employee (Annual) data by YCharts

These are the kind of grind-it-out operating numbers you see at companies with reputations for, well, grinding it out: Wells Fargo (WFC), Southwest Airlines (LUV), United Parcel Service (UPS). Schultz hasn’t cultivated that image, though, too busy mouthing off about mega-trends. One is reminded of the now-ancient Saturday Night Live skit that portrayed Ronald Reagan not as a pleasant above-it-all leader but as a brutal micro manager, personally conceiving of and executing the Iran-Contra transactions.

Maybe Schultz stays up late reading textbooks about logistics and just isn’t telling us, eh?

Sure, his operating executives deserve credit. But the cast beneath Schultz has changed over the years – Starbucks announced more changes earlier today, with the CFO Troy Alstead moving up to chief operating officer – and few companies achieve sustained operating excellence without a CEO driving everyone crazy on the issue. Oh, those “disappointing” same-store sales? They came on the heels of 15 successive quarters of higher same-store sales, never less than 6%. Talk about compounding. Thus does Starbucks realize $1.3 million in sales from the average company-owned U.S. store ($1.1 million in Europe; $900,000 in Asia).

There’s lots of room for growth. Yes, Starbucks talks about China a lot in its growth projections and in fiscal 2014 the China/Asia/Pacific sector gets 750 new stores to just 600 in the Americas. But even growth in the U.S. isn’t through. McDonald’s and Dunkin Donuts (DNKN) compete on the low end against Starbucks, and thousands of little coffee independents on the high end. But compared to the general fast food market, coffee may be both still growing as a category and relatively under-stored.

Let’s be honest: Starbucks coffee isn’t very good. There isn’t enough really good coffee in the world to supply Starbucks’ needs. If one wants fabulous coffee, order if from one of these top-rated roasters (I’m a dedicated Counter Culture man) and make is at home using a pour-over setup or a French press.

But disdaining Starbucks coffee (mea culpa), it’s too easy to disdain its achievement: to hook millions of people on high-priced (if crummy) coffee and espresso drinks, and develop a retail concept that can deal with customers who grab a chair and won’t leave. And then – and this is where things get interesting for investors, even at this late date – running the thing with rigor and discipline.

The operating details I cite above – there are many more for the investor inclined to dig in, and also to unleash financial advisor tools – suggest the Starbucks turnaround story has room to run. The question becomes one of valuation. Are coffee profits worth that much more than burger profits, as we’ve asked a number of times at YCharts?

SBUX PE Ratio (Forward) Chart
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SBUX PE Ratio (Forward) data by YCharts

They are if they keep growing more rapidly than the competition, and if the substantial gains in operating cash flow continue. Some Credit Suisse Analysts writing on the Barron’s website have some interesting thoughts on why Starbucks doesn’t look expensive relative to McDonald’s.

Starbucks is projecting fiscal 2014 overall revenue growth of 10%-plus, a mid-single-digit increase in same-store sales, wider margins, higher EPS and the opening of about 1,500 new stores. A little caffeine jolt to move the earnings season discussion along.

Yes, Howard Schultz will probably keep sounding off on politics, on technology trends, on what a swell boss he is, all seemingly to the exclusion of a discussion of what a productive operation Starbucks has become. He seems to want to be loved. That’s OK. But behind all that he’s building a record as a remarkable operating executive. Sounds dull, but that’s what great stocks are made of.

Disclosure: None

Source: Reconsidering Starbucks Stock And Howard Schultz