After gaining 2% the day before its earnings report last week, Starbucks (SBUX) dropped 5% after the news was reported. The skinny is that despite beating the analysts' consensus EPS estimate for $0.39 this fiscal quarter by a penny, Starbucks only hiked its full fiscal year 2012 (Sept.) EPS forecast to a range that was still short of the consensus view. Also, despite strong growth in the U.S. and China/Asia Pacific, Starbucks reported trouble in certain hard hit portions of Europe, and saw negative 1% same-store sales growth in its segment incorporating Europe, the Middle East, Russia and Africa.
The good news was that Starbucks' global revenues rose 15%, reaching a grand $3.2 billion, thanks to some stellar same-store sales growth in the Americas and China/Asia Pacific regions. America's sales gained 8% in stores open a year or more on improved traffic. The company is also seeking to leverage its vast distribution channel through the sale of various new offerings. In China, working with a younger store base and aided by highly concentrated population centers, same-store sales soared 18%. The company is of course excited about China, noting its expectation for it to become its second largest market by 2014.
Yet, the stock market focused on the weakness in Europe on that particular day, and I think for good reason. Starbucks' Chairman, President and CEO, Howard Schultz, vowed he would cure the company's European woes just as the company had cured its North American issues a few years back. Jim Cramer expressed great confidence in Schultz after the report, and he may be right about the corporate chief, though the greatest of captains cannot navigate through the perfect storm. Here's why I am not buying Starbucks today.
Now don't get me wrong, because I have the same enthusiasm most do about the company's China/Asia Pacific potential should the global environment remain fruitful. However, I'm not confident in the company's assessment of Europe. Their view seems to fit with the popular opinion, that the European situation will get better before it gets worse. I don't agree, and there is nothing Starbucks can do to cure the macro issue that is spreading and intensifying rapidly. At this point, I believe it's akin to trying to stop a ton of bricks from falling in mid air, or if you like, catching a falling knife. Schultz made a point to note just how tough the situation was, and Starbucks will freeze growth through its Europe, Middle East, Russia and Africa region to save economic value. Starbucks will still be adding another 1,000 stores on net globally this year to its plus 17K base.
Not only am I bearish on Europe, but I'm sour on the outlook for the States as well and noting the impact of both on China's economy. With that view, my problem with the company is that it's got a P/E ratio of about 27X its next four quarters' earnings estimate (I took the average of FY 12 and FY 13), which would compare well enough with the 25% growth forecast for FY 13 under normal conditions. However, at such heights, missteps are not missed by the market and trouble is on the radar now. We have a saying in the business that would seem to apply here, and it has to do with the second shoe dropping.
While the company might be adept at solving operational issues or understanding market variances, it and its peers are not going to find it easy to deal with the deep recession I see about to take a hold of most, if not all, of Europe. As of Monday, we discovered Spain officially fell into recession in Q1, and Greece is in a state of depression now. I just heard that the island of my ancestry is now running three regular soup kitchens with hundreds lining up for needed meals served by the Greek Orthodox Church; it's just unheard of there. In my view, the situation is going to be the end of euro zone one way or another; whether it falls apart separately or together is the only question now, if you ask me.
So surprisingly, while many in the market are touting those companies like Dunkin' Brands (DNKN), Yum! Brands (YUM) and McDonald's (MCD), which are selling into emerging markets and extending their growth globally, versus those serving manufacturing there like Caterpillar (CAT), I'm not so sanguine on either segment. So, while the company's P/E/G ratio does not seem out of kilter today, which is what I'm sure Jim Cramer and other enthusiasts of the stock and similar issues are looking at, should earnings expectations fall, the stock price would be left lofty without support beneath it.