Ganesh Kumar

Starbucks: Accept The Addiction

I am a shareholder of SBUX. I started with a small position when SBUX hit 52 week low and have added little by little. My Average cost is now about 26.50. Now to the analysis and digging deeper.
I was also very passionate about SBUX and put in an 52-week low alert. Without looking at the numbers and without looking beneath the surface it is easy to be romanticized with Starbucks.
Of course wherever you look you see starbucks and which ever store you go there are people. I even sat at a store for about an hour to see whether the traffic slows down on a Sunday morning but could see a steady stream of people flowing in. I was more pleased!.

Starbucks is increasing its reach with bottle Frappucino's, Icecreams, choclates and Liquer. Some analyst once compared Starbucks to Amazons in the sense that as how Amazon was able to use its distribution/logistics capacity beyond books into everything now, Starbucks can use its distribution network to market and sell many more things than coffee.
In fact in one of economics book the author refers to Starbucks in London and Newyork and makes a valid point of how Starbucks has cornered all the prime locations in these cities and how it is very convenient for a consumer to get a Starbucks cofee. Would an average $50000 earner take the trouble to walk two block out of the way from his or her commute to find a coffee that is a dollar cheaper NO WAY. So all these are plusses right? I bough more SBUX shares and was patting myself in the back!

Now recently I thought that as I now own some serious amount of Starbucks stock, let me dig deeper myself rather than just listening to others opinion on Starbucks.

I downloaded the less flashy 10K report filed by Starbucks and patiently started reading it. Let me confess that reading through the 10K report requires a lot of patience than reading a blog or an Analyst report which is written in a sensational way (either arguing for bullish or bearish case).

There are couple of things that stuck me as I was reading the analyst report.
1. We all including the company agrees that the greatest growth potential for SBUX lies internationally not in US. SBUX has 171 stores in Manhattan alone!.
2. In many countries abroad, SBUX reports the revenue as "licensing revenues" wherever they have agreement with other partners (ALL middle east, Turkey, Russia etc)
3. I was very concerned about the leasing/Real estate costs for SBUX. I am also worried about their dairy and cofee costs but I think that they being commodities, Sbux can ride through these cycles easily.
As I was looking at these the things rather closely I found the following.

Regarding licensing revenues SBUX reported as follows:
"Licensing revenues, which are derived from retail store licensing arrangements as well as grocery, warehouse club and certain other branded-product operations, increased 19% to $1.0 billion for the fiscal year ended 2007, from $861 million for fiscal 2006. The increase was primarily due to higher product sales and royalty revenues from the opening of 1,229 new licensed retail stores in the last 12 months and a 20% increase in licensing revenues from the Company’s CPG business"

In 2007 SBUX reported 19% increase and licensed 1229 stores. Great right? not so soon. For 2006 you find the following:
Licensing revenues, which are derived from retail store licensing arrangements, as well as grocery, warehouse club and certain other branded product operations, increased 28% to $861 million for fiscal 2006, from $673 million for fiscal 2005. The increase is primarily due to higher product sales and royalty revenues from the opening of 1,156 new licensed retail stores in the last 12 months and, to a lesser extent, growth in the licensed grocery and warehouse club business.
In 2006, licensing revenues increased 28% and sbux opened 1156 new stores only! Remember that most of these licensed stores are abroad. The number of new licensed stores increased but the increase in revenues were much lower.I saw this as a warning sign.

I dig deeper. I started analyzing the margins for SBUX in US and abroad. Here is what I found:

For US, the cost of sales including store occupancy costs as a percentage of revenues is 40.2% and operating income as a percentage of revenue is 14.3%

For international, the cost of sales including store occupancy costs as a percentage of revenues is 48.6% and operating income as a percentage of revenue is 8.1%

The company has been telling that they would be able to leverage the fixed costs better as they open more stores internationally, I AM NOT BUYING it.

I doubt that Starbucks has to shell out a lot internationally for leasing costs for real estate and it is eating into its margins. Also I suspect whether SBUX has the pricing power it has in US abroad. Atleast in emerging countries like China, Middle east and Russia.

We all acknowledge that the major growth for SBUX is going to come from international sales. IF SBUX is pressured on margins for all the incremental sales, we may see revenue growth but not bottom line growth!.

Can some BULL analyst of SBUX dig deeper and give me good explanations why SBUX will be a good buy in the long run?

It is easy to fall in love with SBUX company as you see it everywhere and see a lot of people in the stores you visit. You may even like their coffee. BUT remember this may not justify the stock purchase as a great stock.

I have stopped accumulating (not sold my position yet). I am looking for some deeper analysis on the stock from analysts rather that saying SBUX is like crack and people got to buy it so buy the stock! Come on!