Seeking Alpha
Long/short equity, value, REITs, macro
Profile| Send Message|
( followers)  

For Q3 2012 (most companies' Q2) Starbucks (SBUX) missed by -$0.02 with EPS of $0.43 per share versus an expected $0.45. SBUX also guided lower for its Q4 2012 at $0.44-$0.45. This was down from the $0.46-$0.47 estimate before the Q3 earnings announcement. SBUX issued FY2013 guidance of $2.04 to $2.14. The midpoint of this guidance, $2.17 was -$0.11 below the average analysts' estimate of $2.28 prior to SBUX's earnings announcement. In other words, SBUX missed, and it guided lower in both the short term and the longer term.

When SBUX delineated its forecast for 2013, a few things stick out as non sequiturs. First the EMEA results for Q3 2012 were very weak. They showed a decrease in operating margin of 100bps to 0.9%. This means that net margin was negative. Not many people see the economic situation in Europe improving in the near future. Rather most see it getting considerably worse before it gets better. SBUX did acknowledge that it is now planning to close an unspecified number of underperforming EMEA stores in the next year or so. However, the company also specified that it was planning to open 100 new stores in the EMEA in 2013. This seems a questionable plan, and SBUX should perhaps consider delaying it until such time as the EU is firmly on the economic recovery track. I have seen the often disastrous effects of launching new products or stores in a recessionary environment. The negative aura of the early business environment can haunt the stores or products long term. The company may come to the same conclusion I did. This would mean much lower growth in this area in 2013. If you add the number of store closures to this, SBUX will likely end up with little or no growth (possibly even negative growth) in this area of its business, especially considering the likely added costs of the store closures.

SBUX mentioned that it had seen the first indications of waning of traffic in its U.S. stores in June of this year. That weakness has continued in July thus far. This accounted for some of the weakness in Q3 results. However, from the current indications, the weakness is likely to continue. It may even become more severe as the U.S. economy potentially slows or even contracts in the near future. I point out that the U.S. GDP growth did slow from 2.0% in Q1 of 2012 to 1.5% in Q2 of 2012. Plus the rest of the Americas seem to be following the U.S. lead. SBUX has planned for 600 new store openings in the Americas in 2013. It seems likely these will meet with much less immediate success than previous store openings. Estimates for growth from these new stores are likely too high.

SBUX's results from China and the Asian Pacific countries have looked comparatively strong. SBUX has plans for 500 new store openings in this area in 2013. However, these may not provide as much growth as expected. China's GDP growth slowed from 8.1% in Q1 2012 to 7.6% in Q2 2012. In fact it has been on a steady downward trend for the last couple of years. If it continues on this pace, it may soon encounter huge bad loan problems. Loans that were made with the prospect of 10%+ GDP growth per year often do not do well when growth slows considerably below that. China already has a large amount of empty office space and empty housing. The loans associated with those items may soon start going bad with a vengeance. China is likely sitting on somewhere between $2T to $4T in bad debts. It has already acknowledged about $1T in bad debts. Much of these are associated with municipal infrastructure projects that were not fiscally responsible from the beginning. Significant further slowing could lead to a downward spiral in Chinese growth over the next couple of years. This would dash SBUX's hopes for great growth in the region. The counter to that would be Chinese stimulus. However, this too might put a damper on SBUX's Chinese / Asian Pacific results. Chinese urban household incomes were up 13% year over year in 1H 2012. A stimulus plan by China would likely send them up a similar amount in 2013. YUM Brands (YUM) and others are already complaining about increased labor costs negatively affecting their results in China. The same would have to be true for Starbucks.

Another item that has been touted as a possible huge opportunity for Starbucks is the K-cup business. Recently SBUX has been gaining market share. However, the Green Mountain Coffee Roasters (GMCR) patents for these are expiring in Sept. 2012. This means that there will soon be many new, large competitors in this space. For example, Kroger (KR) is planning to introduce store branded K-cups soon. Folgers (part of JM Smuckers) recently started K-cup products for Keurig brewers. Safeway (SWY) is launching 5 store brand coffees for Keurig brewers. Wal-Mart (WMT) is planning to introduce its own new Esio Beverage system soon. This is basically a brewing machine along with K-cups. Dunkin Donuts (DNKN) has Keurig system compatible K-cups. The list seems endless. On top of this Nestle (OTCPK:NSRGY), with 35% of the global single cup business, Sara Lee with 18%, and Kraft (KFT) Foods with 8% each have their own brewing systems; and each are likely to try to grab a bigger share of the U.S. market now that GMCR is showing some weakness. In short the floodgates have been opened in the K-cup arena; and both margins and profits are likely to become harder to come by soon. The above information should give you huge doubts about whether SBUX can achieve the growth in this area that it is currently predicting.

Finally don't forget that Nouriel Roubini has forecast the "perfect economic storm" for 2013. He has pointed to the following as major causes: the debt crisis in Europe; tax increases and spending cuts in the U.S. that may push the U.S. into recession; a hard landing for China; further slowing in emerging markets; and a military confrontation with Iran. Given that the SBUX CEO attributed most of SBUX's Q3 problems to economic headwinds, Roubini's take on the global economic picture should worry you extremely if you are an SBUX investor.

If you look at the five year chart below, you can see how SBUX did in the last recession. If Roubini is correct, this one promises to be worse for a global company, which SBUX is.

(Click to enlarge)

The most important point in the chart above is that SBUX has just broken through its 200-day SMA. This is a SELL signal. The fundamental data presented above are also a SELL signal. The company trades at a premium multiple of 26.37. It is highly susceptible to economic downturns, which will make it miss its estimates. It seems unlikely to grow as fast as its predictions, and it does not pay the dividend a less economically sensitive, good grower like KFT (2.90%) does with a dividend of only 1.40%. All these factors mean that SBUX is a big SELL now. For aggressive traders it is a short. The chart shows that there is support in the $36 to $40 range. You should be able to achieve good profits with relatively low risk with a short position down to this level. If Roubini's "perfect storm" for 2013 materializes, you may see the stock fall to $20 or below. There is further support in this area. I note that I am not saying that SBUX is a terrible company. I am merely saying that it is facing likely huge economic headwinds. Even its CEO has said that the company is very susceptible to these. It would be foolish to ignore the negative world economic outlook and the CEO. ECB and/or Fed actions might have some impact on this thesis in the short term.

NOTE: Some of the fundamental fiscal data above comes from Yahoo Finance.

Good Luck Trading.

Source: Starbucks Re-Examined After Earnings