SBUX is an evil empire pushing addiction to their cr*p, IMHO
Brother, Can You Spare $3.75? (SBUX) September 2006
Is a morning coffee or two addictive? Is it the fuel for a nation of two-income households? When is enough, ENOUGH?? How about the 40 multiple valuation of the ubiquitous seller of this libation, Starbucks (SBUX:Nasdaq), which recently posted just 4% same store sales growth? Well, one of America’s favorite growth stories may well be stumbling. According to the Wall Street Journal in August, consumers are cutting back on high-priced coffee, fashion accessories, clothing, and other luxury items. Late summer, SBUX, Whole Foods (WFMI), Williams-Sonoma (WSM) - and boat maker Brunswick Corp (BC) and Panera Bread Co (PNRA) missed their comps targets.
SBUX is a well-known and generously-valued consumer marketing success story with 15 years of 5% or greater same store comparisons until July this year. SBUX’s long term goals are to achieve 20% annual sales and 20%-25% annual EPS growth. Its “folklore” is continuously trumpeted by billionaire founder, Howard Schultz, although Schultz, CEO Mike Casey and three other officers have been selling their stock aggressively this year (nearly $100m so far).
And in late September, SBUX was sued foranti- competitive and predatory sales practices such as competitor intimidation and customer poaching (i.e. by providing free coffee in front of other vendors’ establishments).
With 12,000 stores (8500 in the U.S.) in 37 countries and an estimated 73% of the specialty coffee market, SBUX has market power and has just raised prices an average of 3.9%. This price increase may be an effort to get same store sales comparisons back over 5% since comps began missing some analyst expectations in April and fell below 5% in July. Another SBUX response has been to increase U.S. planned store openings from 1000 to 1500 to 1800 this year (versus a 500/year historical average), a move which will expand capex, hurt margins, and possibly cannibalize existing outlets.
Panic Expansion, Failed Diversification and the Holy Grail
Moreover, this panic expansion plan will not hurt new premium coffee pushers including McDonald’s (MCD: NYSE), Dunkin' Donuts, Green Mountain Coffee Roasters (GMCR: Nasdaq) and Caribou (CBOU:Nasdaq). Now the legendary “ambiance” of its stores is being killed by a push to build drive-thru stores (currently 1,300 of 8,500 stores) in high density areas like California with the next push in New York to attack Dunkin’ Dounts there. But McDonald’s (MCD:NYSE) franchises launched a premium coffee under the name Newman's Own early in 2006 ahead of parent company MCD’s own launch of a premium coffee nationally in March. The coffee is enabling MCD franchises compete with SBUX, Dunkin' Donuts and Burger King, which launched its own premium coffee, BK Joe this past summer. Canada’s Tim Horton’s has also entered the fray. Strong, well blended coffee at 50% discounts to SBUX prices may just resonate with some customers facing a sharp increase in mortgage payments starting this fall when nearly 40% of all mortgages reset.
Diversification efforts into new drinks (Ethos Water with Pepsico), breakfast foods (Kellogg), movies (Lionsgate Films), books (Mitch Albom) and couponing have been bungled, maybe highlighting the value of ex-marketing head Greg Maffei (who quit SBUX in March 2006).
Of course, the SBUX “holy grail” is international expansion, increasing its existing 3,500 stores to 15K by 2010. Recent pushes into China, India, Brazil (with Cafes Sereia do Brasil Participacoes S.A) and France. Operating profit margins for the international division over the past four quarters averaged 9.1%, compared with negative margins in fiscal 2003. But new expansion in France and China is moving to second and third tier cities, some where cultural resistance may prevail. In addition, internationally savvy Coca-Cola (KO) is getting into the coffee business, setting up mini-cafes in retail stores, offices, fast-food outlets and movie theaters that will brew espresso drinks in 30 seconds for under $3."We're not going to be in the real estate business - we're going to sell brewed coffee and teas wherever Coke is sold," said Udaiyan Jatar, head of Coke's coffee project
The Street Loves Strong Coffee
The lack of negative opinions on the stock with sponsorship and coverage coming from Goldman Sachs, JP Morgan, CIBC, UBS, Think Equity and new summer coverage from Deutsche Bank is striking. FY06 (Sep) EPS may reach $0.75 when Q4 is reported soon and $0.90 in FY07. But with the U.S. middle income consumer retrenching and the Chinese yuan appreciating (finally) against the dollar, SBUX looks vulnerable during a period of heavy overseas capital commitments.
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