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Why Starbucks' Caffeine High May Not Last


Buy the instant coffee, but book profits on the stock.

Good news for coffee addicts across the nation: You now have a more portable, convenient, and cheaper way to mainline caffeine every morning.

For 20 years, Starbucks (SBUX) has been looking for a way to deliver its dark cups of coffee in an instant form. Today, the Seattle-based company delivered: It began rolling out its new Via instant coffee across the US and Canada.

The C-suite crew at Starbucks hopes to tap into the $21 billion instant-coffee market with a product that makes coffee on-the-go simple and cheap: One packet of the instant brew produces a cup of Joe for less than $1. (Via costs $2.95 for a three-pack and $9.95 for a 12-pack.)

"Based on the success we've had, we feel strongly that we're sitting on a very big opportunity," said Starbucks CEO Howard Schultz during a conference call with reporters, according to the AP. "What's going to sell Via at the end of the day is that it delivers in the cup. Most people will not be able to tell the difference."

Starbucks, which has a market cap of about $15 billion, has battled twin headwinds during this Great Recession: a spooked consumer more interested in saving than spending and competition from rivals offering lower-priced substitutes. However, cheered by improving fundamentals and cost-cutting measures, investors have aggressively piled into the company.

The stock of Starbucks has surged: 75% in the last six months; 40% in the last 12 weeks. Although the company clearly retains a respected, well-known brand and enjoys long-term growth opportunities both here and abroad, the smart move by stock pickers might now be to buy the cappuccino but book profits on the stock.

Confronted by a historically powerful economic downturn, including 24/7 news on a lousy labor market, housing woes, and record deficits, it's no surprise the cash-strapped consumer hasn't been as enthusiastic about shelling out money on high-priced coffee at Starbucks.

From fiscal 2003 through fiscal 2007, the company posted average operating margins of 11.6%. In fiscal 2008, operating margins nose-dived to 4.9% amid weak same-store sales.

Now, however, investors have been willing to bet that better times lie ahead. Starbucks reported a 5% drop in US same-store sales, but that was better than the previous quarter's 8% decline. Head honchos at the company have also worked hard to cut costs, committed to closing almost 900 underperforming locations.

R.J. Hottovy, an analyst at Morningstar who covers Starbucks, tells Minyanville that he expects the company to navigate the current economic downturn, and establish a solid, albeit more modest, long-term growth trajectory.

He argues that Starbucks will benefit from international expansion. The chain has more than 5,000 stores in more than 40 countries, everywhere from France to Austria. It's even been embraced in tea-sipping China.

Product innovation has also proven a hallmark of Starbucks' success, Hottovy says. He thinks the Via instant coffee could ultimately prove a solid contributor.

"With sales still sluggish, it is another way to grow that consumer products group and offset the weakness you have seen in the retail channel," Hottovy tells us.

Via will be available at all Starbucks retail locations in the US and Canada beginning today, as well as in stores such as apparel retailer REI, on United Airlines US flights, and select Marriott (MAR) locations, Omni Hotels, Compass, Office Depot (ODP), Costco (COST), and Target (TGT).

Here at Minyanville, there's some divergence of opinion about Starbucks. This morning, our own Glenn Curtis argued in his article Starbucks Chatter Is Appetizing that he likes the stock more and more these days and thinks there's some upside to be had here.

However, we're not traders but cheapskate investors and, although the long run might look favorable for the coffee giant, we think the stock price is now looking as expensive as a Mocha Frappuccino.

Starbucks is now trading with a forward P/E multiple of 22. The company's price-to-sales ratio is 1.54 versus a five-year average of 0.97, according to Bloomberg data.

So, although there are reasons to stay optimistic, prudent investors might consider looking for a more attractive entry point.
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