Stock of the Day - February 21, 2009 - SBUX

Starbucks (SBUX)

Maybe we should have listened to the disgruntled comedian, Lewis Black. “There is a Starbucks across the street from a Starbucks. And that, Ladies and Gentleman, is the end of the universe.” Well, it might not be the end of the universe, but the overexpansion of the premium coffee chain Starbucks (SBUX) has led to its dramatic recent downturn.

Times were great for the economy, and for Starbucks, in the early 2000s. The economy was booming, consumers were spending, and no one could live without their 3 to 4 dollar coffee every day. So the coffee maker capitalized. By the end of 2007, there were over 15,000 company-operated and licensed stores worldwide. But, Starbucks soon realized that rapid expansion is a double-edged blade.

2008 struck, and with a new year came a new competitor: McDonald’s (MCD). The fast-food giant introduced a coffee blend designed for customer value. The coffee, while missing the Starbucks brand name and premium quality, was cheap. While prices varied on location, stores were selling a 12 oz. cup of coffee for $.99. The new competition has been absolutely devastating for Starbucks throughout the current recession, as coffee drinkers could shave off several dollars from their morning meal by purchasing coffee at McDonalds instead of Starbucks.  The stock was trading in the high $30s in early 2007, and has since dropped to $9.58. Same store sales for Starbucks dropped a discouraging 10% in 2008, while the same statistic for MCD rose by 5%.

Starbucks quickly cut costs and announced plans in July of 2008, to close 600 stores. The closures eliminated an estimated 12,000 jobs. It was the beginning of a recurring downward trend. SBUX reported its 1^st Quarter earnings on January 29, 2009. Net income dropped 69.1% year over year to 64.3 million, or $.09 per share. Revenue fell 5.5% to $2.6 billion, and same store sales fell 9%. The company announced plans to close an additional 300 stores: 200 in the U.S. and 100 internationally. Shutting down the stores would leave 6,000 workers without jobs. The coffee brewer hopes to save $500 million with the cuts.

To the company’s credit, it isn’t taking the beating lying down. CEO Howard Schultz announced two new innovations to invigorate sales. First is a sort of ‘value meal.’ Starting in March, the company will sell a tall coffee in combination with a breakfast item for $3.95. Second, is the release of a new instant brew named Starbucks ‘Via.’

Unfortunately, I don’t think that either new release will bring back the company’s glory days. Starbucks has made its money off of its brand name and the premium value that is associated with it. By lowering its standards with value meals and instant brews, the company is only eliminating future profits. People will come to expect cheaper products, and after the recession ends Starbucks will not be able to bump its prices back up.

This is the ultimate dilemma that Starbucks faces: the company sells a luxury product at a time when people cannot afford luxuries. Consumers will reject more expensive brands to save on more affordable products. As solid a brand as Starbucks is, I highly doubt the company’s stock price will do well in the short-run, and I think the chances that the stock price will ever reach the high $30s again are very slim.   

 

-Matt Schwartz

College Trillionaire