Coffee and Doughnuts (SBUX and KREM)
Sharp: SBUX is another good short opportunity, IMO. Not quite as attractive as KREM, but probably an easier borrow.
Razor
"Big Bucks for Starbucks"
By Roben Farzad
Tuesday March 13, 3:48 pm Eastern Time
SmartMoney.com - Stock Watch
IN A THOUSAND YEARS, archaeologists might be hard-pressed to make sense of the mysterious white paper cups with green mermaids that once held so much significance in certain areas of our planet. But right now, it's clear that Starbucks (NASDAQ:SBUX - news) has become a cultural icon to millions of caffeine-addled Americans — not to mention profit-craving investors.
The Seattle-based coffee brewer's wild success during the 1990s has percolated into the new millennium. For its fiscal first quarter ended Dec. 31, Starbucks saw a 41% jump in net income, beating Wall Street's expectation of 23 cents a share by two pennies. It also increased same-store sales — the industry's most scrutinized metric — by 10%. That helped fuel a full-year earnings surge of 33% over 1999. Investors have responded by sending Starbucks' shares up 32% in the past 52 weeks, compared with the now-notorious 60% decline in the Nasdaq during the same period.
But shareholders might be wise to ponder the staying power of a coffee-shop business that trades at 40 times forward earnings — commanding a $9 billion market cap — in a bear market for growth stocks. Compare that multiple with the puny 16 price-to-earnings ratio assigned to food-sector standard-bearer McDonald's (NYSE:MCD - news), which owns 28,000 restaurants serving more than 43 million people a day. Simply put, Starbucks is priced for perfection.
Unfortunately, the current market environment might not be able to keep Starbucks warm much longer.
First, there's the obvious concern: pricey Joe in tough economic times. Company Chairman and Chief Global Strategist Howard Schultz points to the average Starbucks patron's 18 monthly visits as a telltale sign of brand loyalty. But one wonders how the market for a $5 cup of coffee will fare if unemployment starts to tick higher. ``We're faced with an economy headed down two paths — service jobs are faring well while manufacturing is hurting,'' says industry watcher Robert Derrington of SunTrust Equitable. ``Which of these two areas you're employed in will determine to what extent you'll treat yourself to a little daily decadence.''
And the appetite for such treats may already be waning. Starbucks' same-store sales for the month of February jumped 6% — not bad, until you compare it with a 10% year-over-year gain in 2000. While Derrington appreciates Starbucks' brand loyalty and the desire of shell-shocked tech investors to seek sector safe havens, he thinks the company's lofty multiple should be reconsidered.
That multiple could come under further pressure if the growing roster of Starbucks competitors enjoys some more traction. Here in the U.S., newly public Peet's Coffee and Tea (NASDAQ:PEET - news) has 58 stores and has made impressive headway marketing its fresh roast beans through specialty grocery stores and online and mail-order catalogues. Strip-mall dominator Dunkin' Donuts has been devoting more ad dollars to promos for its high-margin Coolatta and Dunkaccino products, while Street darling Krispy Kreme (NASDAQ:KREM - news) has taken advantage of its newfound celebrity to push its own java. And in the lucrative market for bottled coffee beverages, where Starbucks claims 90% share through its Frappuccino agreement with PepsiCo (NYSE:PEP - news), Coca-Cola (NYSE:KO - news) has extended its joint venture with Nestle to market Coke's Planet Java coffee brand.
And as these and other players continue breathing down Starbucks' neck, the company is continuing an aggressive global expansion strategy. In addition to its more than 3,300 stores in North America, Starbucks has 665 overseas, and eventually plans to operate some 10,000 around the world. It opens three new shops a day, including two a week in Japan, where the concept has caught on like second-hand blue jeans.
But Starbucks' recent foray into Europe is anything but a sure thing. It opened its first store in continental Europe last Thursday in the heart of Zurich, and hopes to expand into Italy, Spain, Germany and France — countries that are notoriously finicky about their coffee and can be unyielding in their distaste for commercial intrusion into their cultures. (McDonald's, for example, is still reeling from a run-in with pyromaniac French farmers.) Starbucks' European gambit will be critical to future earnings, since it has been relying for years on high-octane second-year sales growth from its new stores to counterbalance growth plateaus at older units.
Scarier to some is the company's willingness to sign a deal with Microsoft (NASDAQ:MSFT - news) and MobileStar to offer broadband access for notebook PCs and PDAs at its stores. Investors still remember how Starbucks' last foray into high tech — via ill-fated investments in such Internet ventures as Kozmo.com, cooking.com and Talk City — forced it to take a one-time charge of $42.3 million in November that essentially wiped out its profit for that quarter.
So many ifs, so little room for error. With a stock priced so richly, Starbucks' management must execute flawlessly on every front to keep earnings and share-price growth robust. The slightest bit of staleness could make for a bitter brew indeed.
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