Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

The Search For Starbucks' Soul


With SBUX more than 30% off its all time highs and reporting today, the question for investors is what, if anything, Starbucks can do to get its groove back for investors.

Public genius doesn't die with grace. It lingers on the stage too long, mocking both itself and the true believers with every stumble, loss and humiliation large or small.

Jordan came off the bench for the Washington Wizards. Barry is hitting around .250 on a joyless trudge towards a tainted record. Howard Schultz, the founder of Starbucks (SBUX) and a retail legend easily on par with Michael Jordan and Barry Bonds in their respective fields, is authoring leaked memos bemoaning the "Commoditization of the Starbucks Experience."

For those with perspective, Jordan's NBA comeback simply destroyed the Wizards. Barry Bonds can no longer touch top-level pitching. Just as painfully for all but the most over-caffeinated of believers, shopping at Starbucks, with 14,000 stores worldwide and $10-odd-billion of revenues hasn't been an experience with "romance or theatre" since the Chicago Bulls won their 6th title and Barry Bonds was a lithe base-stealing left fielder with decent, but not extraordinary, power.

Until recently SBUX stock hung in admirably, even without the theatre or "intimate experience with baristas" Shultz longed for in his February note. Last year Starbucks missed a Same-Store-Sales goal because its banana frappuccinos took too long to make. Last quarter, Starbucks cautioned that hitting the upper end of its annual earnings guidance of 0.87-0.89 would be "extremely challenging" due to the higher price of milk. The warning sent shares of SBUX to $25.54, the lowest level in two years.

For investors, the question isn't the validity of the excuses. It's the need to make them at all. Blazing fast growth is to fast-growing specialty stores what fast-twitch muscle fiber is to athletes in their prime; its existence in size much greater than any rivals is what defines them as great. For a specialty retailer, blazing growth makes the speed of your blender and the rising price of a relatively small input cost irrelevant. Starbucks of 1997 would have stopped making banana fraps and raised the price of milk-based drinks. Starbucks of 2006 and 2007 used them as excuses to guide lower.

Adding even more humiliation to the mix, Starbucks doesn't even make the highest rated cup of coffee in fast food America anymore. That honor goes to McDonald's (MCD), a company that's been a great stock but hasn't been a "Go-Go" play since 1972.

The question isn't whether or not Starbucks' days of explosive growth are gone. They are. With SBUX more than 30% off its all time highs and reporting today, the question for investors is what, if anything, Starbucks can do to get its groove back for investors. What Howard Schultz loved about Starbucks was the "experience"; the smell, the relationship and the neighborhood feel. What the Street loved about SBUX was the way they beat earnings and crushed the naysayers quarter after quarter.

Let's see what the company has told us they are going to do to try and recapture their youthful vigor, both as a company and a stock chart. As a tribute to the once great brand, we'll rank the chances of initiative driving SBUX stock higher using the terms Howard Schultz taught the world: Tall (meaning, curiously, a small or negative impact likely), Grande (a moderate or slightly favorable impact on the stock) or Venti ("if SBUX is going to work as a stock, this initiative needs to work huge").

Starbucks as Hang-Out

Howard Schultz desire to recapture the smell and ambiance of a neighborhood coffee shop must drive current management and… um… "bean counters" to distraction. What Starbucks is selling is consistency of service. Schultz memo decries the fact that SBUX "sold it's soul" in the name of ROI when the company went to automated cappuccino machines and vacuum packed (read: smell-less) bags.

Starbucks is trapped in the middle of wanting to be both the fastest place to get a decent cup of a coffee and a nice spot to hang. Even at $5 for a cup of coffee, selling filtered water is a volume business. Making the store more crowded and "ambient" just makes it a slower place to get coffee. McDonald's has higher-rated coffee and orange plastic chairs (the purpose of which is to invite customers to leave ASAP); there's a lesson, and a threat, to SBUX in the McDonald's approach.

I prefer Starbucks coffee to McDonald's. But I really prefer not having to kick my way past a dozen people on laptops and cell-phones on way to ordering a very expensive cup o' Joe. I'd downgrade my coffee selection in exchange for a place to sit.

Starbucks has gotten a great price for selling its soul. Making operations more efficient, and great real-estate acquisition, is how Starbucks got a $20 billion market capitalization. Peet's (PEET), to name one of many small-cap Starbucks competitors, has a comfy environment, great bagels and a market-cap of about $350 million.

You don't get a money-back guarantee when you scalp your soul and Starbucks shouldn't want to try.

Rating: Tall… If Starbucks moves towards "driving the experience, rather than the volume," the stock goes lower.

Starbucks as a Retailer of Books, DVDs and CDs

Starbucks has a decent little business with these offerings. They've carefully selected their partnerships (Akeelah and the Bee, Paul McCartney may or not be your cup of tea but they don't damage the SBUX brand) and sell generally high-quality, coffee-related goods.

To the extent these partnerships are financially neutral or slightly profitable, they help the SBUX cause. To the extent they are distractions or, even worse, cited as "Growth Drivers" by management, they are tragic examples of a company without focus. Your tell is how high up in the Starbucks press release the company cites "other retail". If you're long SBUX, you don't want "other retail" anywhere near the front page of Third Quarter Results press release.

If Paul McCartney or Dave Matthews is mentioned in a bullet point as a "financial highlight", you may want to sell your Starbucks stock.

Rating: Grande'… Add-ons are an okay business and a decent substitute for actual ambiance. It's just not a business that's going to move the stock higher.

Pricing Power

Here's your easiest "Tell" for whether Starbucks will, or should, go in the direction of speeding customers in and out the door or more towards Schultz vision of recreating a nice-smelling neighborhood "hang" where you can bond with your Barista ("So… ummm… did tattooing your eyelids hurt?"):

Starbucks just raised prices for the second time in 10-months.

If those price hikes lead to a higher top and bottom-line, meaning, if Starbucks is able to effectively get customers to pay more for (arguably) better coffee, the chain will be all-systems go on focusing on the experience.

If, on the other hand, the price hikes lead to a drop in business (and the warning based on milk-prices suggest it will), then Starbucks acolytes should brace themselves for a drift towards naked commoditization of their favorite hang.

Rating: Venti… If Starbucks can't raise prices, they are, in fact, a commodity chain. There's plenty of room to cut costs in Starbucks but it won't help the stock until the mid-teens… As in: if Starbucks can't effectively hike prices the stock won't turn around until around 2015.

Starbucks as International Juggernaut

Starbucks has 10,000 US stores and 4,000 overseas. The company has a stated goal of 36,000 Starbucks.

"Overseas" is a much larger market opportunity both in absolute numbers and due to complete and utter domestic saturation of the Starbucks brand.

Rating: Double Venti Jumbo… So big I had to make up a whole new order. American retailers have a checkered (at best) record of going overseas effectively. If Starbucks can't buck the trend, the stock is dead money.

Throw it all into a huge mug and gulp it down and my non-advising conclusion is this: Starbucks has a lot of near-term bad news in the stock already. Any sort of beat in Wednesday's report could, and should, lead to a trading bounce.

That said, if the company can't prove pricing power and get traction overseas, they are going to go the route of Jordan, Bonds and, more germane to the story, The Gap (GPS) circa 2001; the stock will grind its way lower until, finally, it's just a fond memory of the growth-retail world.
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

Featured Videos