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Starbucks Investors Wake Up, Smell Coffee

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Caffeine produces poor results in first quarter.

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Minyanville is proud to welcome Glenn Curtis, our newest professor! Curtis has worked as a financial writer at a series of both web and print publications, including TheStreet.com/RealMoney.com, Worldlyinvestor.com, IndividualInvestor.com, Registered Rep Magazine, and Advanced Trading Magazine. Please join us in welcoming Glenn to the 'Ville!


The coffee grounds were in the filter and the water was poured into the top, but nothing was percolating.

Starbucks (SBUX) reported second quarter results after the bell on Wednesday. The slowing economy and the rising cost of gas and food apparently took its toll on foot traffic at the coffee retailer in the period ended March 30th.

As per the Starbucks press release:

Net revenue increased approximately 12% from $2.3 billion last year to $2.5 billion in the most recent quarter. U.S. comparable store sales were down in the mid single digits. Net earnings in the period totaled $108.7 million, which is down about 28% from the $150.8 million it posted in the comparable period last year. Meanwhile earnings per share came in at 15 cents, which is down 21% from the 19 cents a share it earned in the year ago period. Analysts had been expecting the company to earn roughly 21 cents a share on $2.63 billion in sales. For the full year management suggested that earnings could come in below the 87 cents a share it reported last year.

This news doesn't come as a particular surprise. Last Thursday, before the opening bell, Starbucks pre-announced the bottom line shortfall.

However, what comes as a bit of a surprise was the depth of the problems the one-time high- flier is experiencing. More specifically, the press release detailed the margin pressure the company is seeing. Its cost of sales (including occupancy costs) was up 190 basis points to 43.8% of revenue. The soaring cost of dairy was to blame. In addition, its operating margin slipped more than 300 basis points to 7.1% of revenues.

What was even more disturbing was that the company's CEO, Howard Schultz, indicated that he expects approximately 1,020 total net U.S. store openings in fiscal 2008. That's an issue because as recently as January he ratcheted down opening expectations from 1,600 to 1,175. In other words, this demonstrates that the situation appears to be worsening - and fast.

To its credit, Starbucks is increasing its international exposure through new openings across the pond. But whether or not that strategy bears tangible fruit in terms of earnings, or gets Schultz closer toward his longer-term goal of having 40,000 locations (it expects to have just 21,500 under its belt by the end of fiscal 2011), remains to be seen.

In any case, Starbucks has its work cut out for it if it expects to match McDonalds (MCD) in terms of footprint. And blue-collar Dunkin Donuts, beneficiary of a 2006 capital infusion, hopes to issue a stronger challenge going forward.

The results from Starbucks are an obvious concern for its shareholders. However, some of the problems it's experiencing aren't unique to it. High occupancy and food costs are a problem industry-wide. Moreover, its important to remember that companies that are backed into a corner typically respond by aggressively promoting their wares. Long story short, fast food and quick service investors should be aware that those businesses are vulnerable despite their lower price points and attractiveness in a slowing economy.


For more on Starbucks, look to Hoofy and Boo as they give you the scoop.


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No positions in stocks mentioned.

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