Tag: sbux

I have been saying this since February and if I was a shareholder, I would be asking management why they took so long to admit this to you, rather than reaffirming guidance as recently as May. None of these issue are new, unless they were hoping they would just go away. Incredible.

Shares of Starbucks (SBUX) imploded to a near two year low this morning after CFO Michael Casey, said meeting the top end of its 2007 profit target will be “very challenging.” The company had set a range of earnings of 87 cents to 89 cents a share for the year but Casey, speaking to a conference in Chicago, cited “rising dairy costs and soft transaction growth” as factors that are weighing on the bottom line. Shares were down about 3% at $26.49 in morning action.

In May, when Starbucks was still blowing smoke up your, well you know where, I was saying “Starbucks, which uses an estimated 93 million gallons of milk a year, is looking at a $279 million milk bill in 2007. While it may not seem a lot to a billion-dollar company, it does equate to 36 cents a share, an increase of about 9 cents, or about 10.3% of profits, over 2006. This does not include the price increase to be incurred from changing the percentage of hormone-free milk from 27% to 37%. Starbucks does charge 50 cents more at some locations for this milk, so it must cost considerably more, no? When you are guiding 83 to 87 cents a share and 18% growth, the 10% of that in milk costs is huge.

Then, when management continued the deception with their 2% milk move in “response to our customers requests”, I opined:

“This is all about price and Starbucks doing anything it can to reduce rising costs in the face of stagnant store traffic. According the USDA, 2% milk averages 8 cents a gallon less than whole milk and when you buy almost 300 million gallons a year, 8 cents a gallon adds up real quick. Starbucks can try to gloss over this by saying they are “listening to our customers” but the cold hard reality is they have been making drinks this way for almost two decades now and no one has complained. If they really were listening, they would have eliminated all milk with growth hormones from the stores, but that would be expensive and negatively effect profits. The tell tale sign here is that they are cutting costs, not raising prices like they have in the past. This is perhaps the most public recognition that even they feel they are at the top of the price range and going higher here will cause even more defections to McDonald’s (MCD) than they have already suffered.”

So now the truth finally comes out today and shareholders, down over 20% since January and believing in management are getting killed again today. Shareholders should be outraged and it is not because milk prices or coffee prices are going up, they have no control over that.

They should be outraged because management apparently still believes in the face of all empirical evidence that they exist in an business category of one. When CEO Jim Donald says “we do not really consider our competition” despite stagnant store comps, there is a serious problem. This is painfully obvious when you consider this store growth stagnation directly coincides with product (coffee) improvements at these non-existent competitors.

Shareholders should be outraged because for almost 7 months now management has been in denial about their business and if you believed them, you have lost a boatload of money.

There are two options here for Starbucks and neither one is good. Either they do not know what is happening out there, or they did and lied about it. When some guy in Massachusetts is more honest with you about a company he has no financial interest in than the people you entrust to run it, there is a serious problem.

Upgrading it’s rating on McDonald’s (MCD) shares to “buy” from “hold,” and bumping it’s price target to $61 from $45 (20%) saying the company “is poised to capitalize on global economic growth and key consumer trends in the United States”, Deutsche Bank enlightened clients to the obvious in a note Friday. Yeah. If I was a “client” I would be asking, “You are just only getting this now?”

Just in case “clients” were not mystified enough, the firm cut its price target on Starbucks Corp. (SBUX) shares to $32 from $37, saying “The downside of McDonald’s getting coffee right is material to both same-store sales and the global growth opportunity,” they said. “We see several obstacles to higher returns and valuation for Starbucks.”

The timing of this for investors is nice as Starbucks shares now sit at multi-year lows and McDonald’s sits at multi-year highs.

“McDonald’s sits at the crux of key positive trends in the U.S. restaurant industry, including Quick Service Restaurant resurgence, an expanding beverages opportunity, and a health/wellness slant (with a focus on women and kids), Deutsche Bank said. No kidding!?!

I have been stumping this very line of thinking since January here, here and here and other times but I think you get the point. In the meantime Starbucks shares have fallen over 20% to levels not seen since October 2005 (they will fall further) and McDonald’s shares are up by some 20%. If you are a Deutsche Bank client, you may want to be asking them what happened.

Apparently the only person who is farther behind the curve here is Starbucks CEO Jim Donald

Two weeks ago I wrote, in a post about Walmart “Maybe we could take some of the $7 plus billion you are sitting on and buyback a meaningful amount of shares? WalMart (WMT) is increasing cash at an over a billion dollar a year pace and last year spent just over that on share buybacks. It would appear folks at Walmart felt the same way as today the board announced a new $15 billion share repurchase plan that replaces the existing $3.3 billion one. In that post I said that CEO Scott just wasn’t “getting it” and had to go. Seems like he may be turning thing around.

A couple of weeks ealier I wrote “There seems to be a trend recently in former high flyers like Wal-Mart (WMT), Starbucks (SBUX) and now Home Depot (HD) to not fully recognize that they cannot continue to just grow and grow to get results. There comes a point in time where you begin to just cannibalize your own customers. Rather than focusing on their current locations and improving them and their customers experience in them, they still have an almost myopic focus on more locations. All three are experiencing discontent among many of their core customers as they have felt “neglected” or taken for granted and are leaving for competitors like Target (TGT), Dunkin’ Donuts, McDonald’s (MCD) and Lowes (LOW) whothey feel more appreciated by, who have grown smarter, and have retained what made them popular. As a result, all three are experiencing difficulty and an onslaught of negative sentiment.”

Again board does agree as it was announced that they are scaling back their expansion plans from 250 to 270 stores a year to an average of about 170 a year for the next 3 years, reducing capital expenditures to about $15 billion in 2008.

Now the saving will allow Walmart to fund the buybacks and spend more time enhancing our shopping experience. A novel idea.. Details are still seeping out of the meeting so it remains to be seen exactly how soon the shares will be repurchased so final judgment will have to be left until we know all.

Seems like ‘Ole Lee may be getting with the program. Maybe he’ll turn out to be a keeper.

Starbucks recently met its expected earnings number of 19 cents per share, representing 18% earnings growth. Great, right? But does that make it worth paying 36 times earnings? I’d say no.

Let’s look closer. In the first quarter of 2007, Starbucks (SBUX) bought back $50 million worth of stock. In the second quarter, that number exploded to $513 million, or 17.1 million shares. This represented 2.1% of diluted outstanding shares and was the reason Starbucks met expectations. After all the negative publicity recently, a miss would have led to a share sell-off and more stories about the “end of the line” for Starbucks.

While I applaud share buybacks as a way to enhance shareholder value, Starbucks cannot continue to spend $500 million a quarter to reach earnings estimates. One also has to consider that Starbucks’ margins will be under pressure from higher costs, and that store traffic growth is anemic.

Domestic same-store sales transaction growth was a paltry 1%, leading me to wonder when CEO James Donald will finally admit McDonald’s (MCD) coffee offerings are affecting sales. He never had to address the issue, as not a single analyst’s question on the earnings call broached the subject.

After the earnings announcement, in an interview on CNBC, Donald said “we do not really consider or discuss our competition.” He’d better start. They are stealing his business. Attracting only 1% more people per quarter will not fuel the long-term growth rate of 21.9% that analysts expect.

Another problem for Starbucks is ethanol–hardly what investors might expect to trip up the coffee company.

This year, the U.S. ethanol industry will produce over 5 billion gallons and use more than 1.5 billion bushels of corn, pushing prices near $4 a bushel. Dairy farmers are seeing the cost of feed jump and are finally able to pass that on to consumers. After years of flooding international markets with surplus milk products, the European Union, under heavy pressure from within, has curtailed its $59 billion annual subsidy system, at least where dairy is concerned. Combine that with drought conditions in New Zealand and Australia, two big milk-exporting countries, and it makes for tight supplies worldwide–and higher demand for U.S. product. Milk farmers, who collected 12.3% less for their milk in 2006, are fully intent on making that up this year.

“The price this year is not just going to beat the record by a few cents. It’s going to knock it out of the park,” Michael Suever, senior vice president for milk procurement at Chelsea, Mass.-based HP Hood, told the Boston Globe in April. Prices for raw milk are expected to rise at least 25% this year.

Starbucks, which uses an estimated 93 million gallons of milk a year, is looking at a $279 million milk bill in 2007. While it may not seem a lot to a billion-dollar company, it does equate to 36 cents a share, an increase of about 9 cents, or about 10.3% of profits, over 2006. This does not include the price increase to be incurred from changing the percentage of hormone-free milk from 27% to 37%. Starbucks does charge 50 cents more at some locations for this milk, so it must cost considerably more, no? When you are guiding 83 to 87 cents a share and 18% growth, the 10% of that in milk costs is huge.

We need to now look at biodiesel. Currently, Brazil is famous for two things: coffee and ethanol. Its national ethanol program has allowed it to become independent of imported oil, and now it’s turning its sights on biodiesel. Researchers have found an economically viable way to turn coffee beans into biodiesel. The oil-extraction from coffee bean rate, now at 92% to 94%, means the project will begin next year, and this year’s harvest will be affected, as coffee bean supplies are built up in anticipation. The project will enable coffee producers to produce enough biodiesel to power all their farm and agricultural equipment.

Why does this matter to Starbucks? Brazil is the world’s largest coffee producer and exporter, and this study contends that up to a fifth of coffee production will be used to produce biodiesel.

Let’s go back to Econ 101: When you constrict the supply of an item and have constant or increasing demand, price must increase. Starbucks, which already gets $5 for a cup of coffee, will feel the pinch. How much are people going to be willing to pay for a cup of coffee? Like all products, raising prices depresses demand. In the case of Starbucks, I think the effect of price on demand is more dramatic than commonly thought, as quality coffee can now be had at McDonald’s for a fraction of Starbucks’ prices. All coffee producers and sellers will be affected by the price increase, but when you are at the top of the price ladder and have painfully slow growth that is already a result of those lower McDonald’s (MCD) prices, that pain may be more immediate and severe.

When you add the Brazil situation to the recently announce Ethiopia settlement that now has Starbucks paying additional royalties for coffee from that country, Starbucks is now facing an onslaught of input price increases with not much wiggle room on the revenue side. When consumers are looking at $4 a gallon for gas, will they cut back on the $5 latte and go for the $3 one at McDonald’s? I bet they will.

Everyday gas prices hit a new high record level the folks people love to blame are the oil companies (Exxon (XOM) is the main whipping boy), the Iraq war, a Bush / Cheney conspiracy or the local gas station. As a matter of fact they blame everyone except the real culprit, themselves. Year to date gasoline demand is at a record 9.2 million barrels a day. Much had been said in the news about refinery outages and there have been a few but they have been able to keep up increasing production 3.1% which is ahead of the 2% increased in demand. Note that it is ahead of the increase in demand, not usage. In fact, refiners have been able to meet 96% of our highest even demand. This compares to 93% of demand last year and is above the 5 year average of 95%.

This means that despite you and I demanding more gasoline than ever, refiners are doing their part keeping up production. This demand and inventory depletion has lead to prices at the pump surging 43% this year past post Katrina levels to $3.13 a gallon nationally on Friday and seem to be heading past the inflation adjusted all time high of $3.22 set in March of 1981. For me, I cannot get too worked up about gas when I pay $3.40 a gallon for milk, $7 a gallon for coffee at Dunkin Donuts, almost 6 times that at Starbucks (SBUX) and $6 a gallon for water at a ball game.

Savvy investor will be buying refiner stocks like Chevron (CVX), Exxon, BP (BP) and Valero (VLO)as prices and demand will not slow for at least the next 4 months, leading to plenty of profits.

So if refiners are doing their part, why have gasoline inventories dropped 15% between February and April to the lowest levels since 1956? The main culprit? A strike at a French port that has decreased gas exports to the US 9.6% or 109,000 barrels a day and is responsible for almost the entire shortfall.

This works out fine, it is much more fun to blame the French that ourselves anyway.

There have been a slew of articles the past week about the price of Starbucks (SBUX) shares and whether or not now is the time to buy them. Let’s look closer. Currently Starbucks shares trade at $28 each for a PE ratio of 31 times this years 89 cents a share earnings estimate. Many people consider this a bargain saying “Starbucks shares have not traded at this level since Oct. 2005.” But is Starbucks situation now the same as then?

In a word, no. If they hit their EPS growth goal, Starbucks will grow earnings this year 18% vs the 30% they grew them in 2005 and as each day goes by, that “if” becomes larger. A closer look at last quarters earning shed some light on upcoming difficulties. Earnings were met chiefly due to an unusually large $500 million share buyback that enabled Starbucks to gloss over the fact that margins continue to deteriorate. This buyback becomes even larger when you consider in all of 2006 only $695 million worth of shares were repurchased.

What has not been discussed is the dairy and coffee situation. Both are going to experience an explosion in prices this year and Starbucks did disclose on the recent earnings call that they are not able to “substantially” hedge against these increases because a buyer for the hedge on the other side is not available.

Translation? Everyone knows these prices are going up. So, other than additional prices increases to their customers, Starbucks has no way of avoiding these cost increases going directly to the bottom line. Add the fact that they only served 1% more people last quarter, you now have a recipe for accelerating margin decreases and slowing revenue growth.

This deteriorating margin picture may now begin to effect growth plans. When margins continue to decline, in order for Starbucks to retain it’s over ambitious growth, it will need to rely increasingly on debt. Note that in the recent quarter $488 million net in debt was issued which was more than twice the sum total of the past 6 years.

So what price then? Shares have to fall substantially from here before anyone should consider them. As the chart below illustrates, Starbucks has traditionally sold at a slight premium PE (1.25 to 1.5 times) to it’s growth rate.

eps % PE ratio
1996 20 50
1997 50 49
1998 22 46
1999 27 50
2000 29 47
2001 28 45
2002 22 39
2003 21 36
2004 41 40
2005 27 43
2006 20 46

Of the times it did sell at more than that (2+ times), the following year featured increasing growth “justifying” that “froth”. The aberration in the PE vs. growth rates trend has been from 2006 on. 2006 featured dramatically slowing growth for the third consecutive year and an increasing PE over the same time span. This was the genesis of my original post and shares since then have acted accordingly down 20%.

With that rate at this year at MAYBE 18%, its current 31 PE has shares grossly over valued. A price range of $22 to $27 put us in a historic PE to Earnings Growth range. Now, that also assumes they hit the 18% EPS growth this year which I am doubting more as each day passes.

With all the uncertainty surrounding the company at this point, I could not even begin to consider shares at any price other than the lowest end of the range, $22 or another 21% lower than current prices as I expect EPS growth to slow more.

Disclaimer: I have no nor have I ever had any position in Starbucks

So, I noticed something very odd the other day. Folks take their “apple-holism” very seriously. I wrote a rather benign (I though at least) piece while having coffee the other morning about my observations on the new iPhone coming out June 11th. You can read it here. If you do not care to read it, the gist was that a $600 cell phone will not be a hit. I went on to explain some of my issues with it and finished by saying Apple (APPL)should “cut the price to $299 and you may have something”. The responses were so vitriolic you would have thought I cast aspersions on the virtue on their mothers, grandmothers and sisters all at once.

My favorite response was “you should be banned from the internet for being so gay. f-off dork face.” Well said, thanks for thinking that one through. If you are going to be insulting, let’s at least put some originality in it and make it a good one. My four year olds can do better.

Enough of that. Another response was “the overwhelming # of pro-iPhone responses received (i.e: potential iPhone buyers) thus far should make you want to reevaluate your opinion on the iPhone.” Actually is doesn’t. If it does anything, it makes me question the lofty prices level of Apple’s stock and the potential pain investors may be in for. Here is why.

In January I wrote when Google was approaching a new all time high, “You should expect the multiple for Google to contract to a range commensurate with its growth rate. If that rate this year is around 30% expect the pe to shrink to about 30 times 2007 earnings. That give us a price for Google shares of about $450 a share. In other words, Google is overpriced. It is priced for its current growth rate, when that rate slows as it must (law of large numbers) its price will fall.

Google is a great company with a wonderful product, its stock is just too expensive.”

The responses I got from “Googlites” was no different that what I got from Apple holders yesterday. Just substitute the company name and the gist of them is the same. I am an “idiot”, “just do not get it”, “Google hater” (this despite me saying it was a wonderful company). I followed up with another piece days later and this one recently. The responses have all been the same.

Google (goog) share price since first article? Down $40

In February I penned this article on Starbucks (SBUX). Again the responses where the same as the Google and Apple episodes. Again I said “great company with a wonderful product, it’s shares are just overpriced”. No matter to the “Starbazis”, I apparently hate everything Starbucks (not true). Then in March, Founder Howard Schultz penned a memo echoing the sentiment in my first post. This is not to say Mr. Schultz reads me but to say that my piece was not the apparent Starbucks bashing article it was accused of being. For a current take on Starbucks, visit my friends at the StockMasters

Starbucks share price since first article? Down 20% to a 52 week low

What is my point? Emotion. It is the enemy of every investor. When people feel so strongly about a company or a product that any criticism of it causes such anger and hostility, they no longer have the ability to take a rational look at their investment. I have no position or ever have had any in any of these three companies so the eventual outcome of my opinion means nothing to me financially. That also allows me to look at them for what they are, not what they have been. It is ironic that most of the responses I got focused on the past and have a blind confidence in the future. I also find it funny that almost to a person they have owned shares in the companies “for years”, “since they went public” or “at $10 a share”. Has nobody bought them in the last 5 months? Who is buying and selling all of those shares everyday? Another favorite response has been “people like you have been saying stuff like this for years.” Okay, I do not know what “like me” is (I will assume it is not complimentary), but I have not said anything before Jan. and Feb. 2007.

Comments like those are my very point. Warren Buffet said “if you spend too much time looking in the rear view mirror, you will not see the potholes coming up in the road”. Google and Starbucks shareholder have either missed them or refused to see them.

Now to the “Apple-holics”. The Motorola razor at the time it was introduced was “cutting edge” cell phone technology and priced at $500 and up. It did not sell well until it could be bought for $199. The original iPods were only moderately successful until they could be purchases for under $200 and then $100. The Blackberry recently saw its share of the pda market go from 4.9% to 20% in one year. What happened? I can now get one for $99 rather than the $299 they were previously sold for. They have not increased their share of the business (professional) market, (which is 50%) they have increased their consumer market. No matter what anyone thinks, consumer cell phones are a commodity and in commodities, price rules. Especially with an almost disposable product like a cell phone that gets washed, dropped, sat on, lost, etc.

It should be noted that I gave Apple huge credit saying that they do not even need to go down to $99 for the iPhone to sell, just $299. That does mean I see value in it, just not $600 worth. Will it sell, to the “apple-holics” yes, to the masses? Not at $600.

One also has to consider that it will only be available initially to the 47 million people who have ATT wireless. According to the presentation, Apple expects 10 million units sold by the end of 2008(it will be available in Europe at the end of 2007 and Asia sometime in 2008). So we expect 1 in 4 AT&T users to have a iPhone? Won’t happen….

So once this rolls out how do we judge my accuracy? Easy, anything less than the 10 million units sold at $600 by then end of 2008, I win. If they drop the price? I win. If they ditch AT&T prematurely and open it up to all wireless companies? Partial win for me as they will do this eventually anyway. If they sell more than 10 million at $600 by then end of 2008? Tell me how wrong I am, you will know where to find me.

With the emotion these folks exhibited, there has to be froth in Apple shares. No matter who runs a company, they make a mistake and stumble. Steve Jobs and Apple will eventually. With the froth and emotion in the shares and with the shareholders, that eventual mistake will result in a very hard lesson for people. Unbridled exuberance on the way up results in desperation on the way down and those two emotions make for a wild ride for shareholders.

I will repeat a comment I gave to almost all the Starbazis, Googleites and Apple-holics after their comments and email. I hope I am wrong if you are a shareholder, I do not want people to lose money and hopefully potential investors have resisted the urge to buy and have saved themselves significant losses and maybe some current ones sold out and saved some angst. I hope I am, it is just that, I haven’t been.

I await the angry emails and comments. You can call me whatever you want, just not “wrong” 🙂