Am I Too Much of a Pollyanna on Starbucks?

I’ve been a big fan of Starbucks (SBUX) stock, saying to anybody who will listen that if I were allowed to buy a stock and put it on the shelf for a few years — buying more as it falls — Starbucks would certainly be one that I would consider.

Among the reasons: It’s a strong brand (and I like brands), Howard Schultz has his reputation at stake, coffee ain’t going out of style, McDonald’s (MCD) is limited as a competitor in terms of its coffee offerings and if ever there were a time to do a turnaround, it’s now — during a horrible economy — when the business would have done poorly, regardless. (And I didn’t even mention China.)

In the wake of yesterday's warning from the coffee company, one private retail analyst, who has disagreed with my premise from day one, wrote to say:

This was/is an easy short. There'’s no opportunity to drive incremental traffic, only an opportunity to keep the customers they have. Howard Schultz is going to become known as the next Michael Dell. Visionary comes back and finds the company’'s current challenges much different than building a nascent growing brand in a relatively new industry.

He’s not the only one to say I’m too much a Pollyanna (who, me?) on this, even if it’s long-term positive. (My problem is that I can’t get McDonald’s out of my head; remember, years ago, when everybody said it was destined for demise?)

So, tell me, who will ultimately be proven to be right? Me, or my retail analyst pal? And why? If you side with him, comments like “Starbucks sucks” won’t cut it.

Disclosure: No positions

Comments

[turneight]

SBUX brand and coffee is really good and improving, and on average the Partners are productive enough. But there are a few head winds....

- Partner lawsuits with a $100M award in California with more suits being brought forward.

- Higher input prices for milk, sugar, etc.

So at a very modest growth rate SBUX deserves a 10 to 15 PE based on $0.87 in earnings. That would put the stock at $10 give or take a dollar.

I would start to buy this stock at $12.00 all the way down to $10. An expect either private equity or YUM brands or Hershey to do a leveraged buy out. New management should increase prices to become profitable.

[mtp]

Herb -

I agree with both you & your analyst friend. While this is a strong brand, which does have value, this stock is crumbling due to multiple contraction. It no longer is the guaranteed growth engine it used to be and so that premium as well as the growth factor are being reduced by the market.
International has promise here but currently it's a US stock with 2 strikes against it - weak economy and increasing commodity costs. Add it their moves into low end coffee, and that's lower margins to boot.

Agree with reader above, this stock would be more fairly priced $10 or lower.

[CM in MA]

Herb, Gotta go with the retail analyst on this one, for the short term. Even at $15.70 (pre-market) the price is still too high given the near term growth expectations. I anticipate more rough quarters, perhaps even a rough year, ahead for SBUX. Looks like earnings will be flat yoy 2007-08. 2009 will get taken down also. Long term, you're correct: demise is not in the cards for Starbucks. The question an investor must answer is what is a fair price for Starbucks given its future growth projections. Answering that is tough in the current environment. This company has a full plate: execution problems, high commodity costs, and increasing competition to name just a few. Then there are a few minor cracks in the company's finances. Just off the top, there's some recent debt (at a very manageable level) and their current ratio has deteriorated. My humble opinion is that 18-20x 2008 earnings is too steep, as is 4-5x book value. I think turneight's comment above has it about right. $10-12 starts to get interesting. I'd expect it to bounce along the bottom a bit as the cloudy earnings picture needs to clear.

[BoulderBiker]

Herb, I'm off to Hong Kong and China again this summer. There is a regional coffee player their by the name of Pacific Coffee Company. On my last trip, I wasn't convinced that Starbucks was doing a booming business, but I will pay more attention this time.

PS. I much prefer Pacific Coffee. Whenever someone I know travels to Hong Kong, I ask them to pick up some beans for me. I haven't purchased Starbucks beans in years!

[GoldDustChuck]

I'm with your analyst buddy. Starbucks is the growth of the past. Among the many things they might consider doing, however, is becoming more shareholder friendly. They might consider paying a dividend, for instance. Some people (and I'm one) won't consider an investment without one.

[RafaelGrillo]

As much as it hurts me, I think Starbucks is in a difficult strategic position. Starbucks taught America how to drink coffee. That served them well, and being the only real choice for many years, growth just followed. The problem is that they also taught their potential competitors how to prepare coffee. This is the typical cycle of disruptive innovation. The consumer now has choices, and at a lower price: not only McDonalds, but DD and other smaller coffee houses. Starbucks coffee is not the golden standard anymore. The only real advantage they have at this point is their distribution. Hard to grow on that one alone. Their real opportunity to reactivate growth: aggressively leverage their brand internationally, where the Starbucks experience is still innovative and aspirational. Until an aggressive international expansion strategy is not presented, you are better off betting on McDonald's coffee... and salads.. and burgers...

[GKM]

I've been long and wrong on SBUX for a few points but now am a believer in the $10 target. The brand is strong, as long as Howard doesn't muck it up, so growth will continue but at a more sedate pace. As well until economic circumstance improve and commodity prices come down again, I think it will be tough to drive a lot of international growth at this point. However, the great thing about coffee is its addictive so this isn't a fad like Crox and will be a buy once again.

[ku4a]

Long and wrong here too, but I'm holding. An improving economy will bring back the $4 coffee buyers.