Starbucks: Losing Traffic, Making Excuses
November 19, 2007
| about stocks:
SBUX
Starbucks (SBUX) is caught between market share, maximizing every penny per
cup and growth. They have promised to expand to 40,000 stores and to
back off this expansion would scare investors. This is the problem with such bold
predictions much like Home Depot (HD) is seeing with the shares
repurchase plan. If you can't deliver, people are less than pleased
with you. This causes management to fight reality. Always under promise
and over deliver.
For the recent quarter ended Sept. 30, Starbucks posted net earnings of $158.5 million, or 21 cents a share, compared with $117.3 million, or 15 cents a share last year. Quarterly revenue was up to $2.44 billion from $2 billion last year. Analysts surveyed by Thomson Financial were projected 21 cents a share on $2.43 billion in revenue. Starbucks said it expects earnings per share in the next year of $1.02 to $1.05 a share, at the low end of the current $1.05 estimates.
For the full fiscal year, Starbucks earned $672.6 million, or 87 cents a share which was at the low end of the 87 cents to 89 cents the company predicted. It was not until July the company lowered expectations to the 87 cents a share.
The news that really mattered? A 1 percent drop in traffic, the first decrease since the company started releasing those numbers three years ago. CEO Jim Donald said the 1% dip in average transaction per store in the U.S., the first decline since Starbucks started disclosing this measure of customer traffic about three years ago, isn't a sign that the company has built stores too quickly or that the market is showing signs of saturation. "The saturation comment's overblown," he said.
For once I agree with Mr. Donald. Starbucks has not over-saturated the market with physical stores. What they have done is over-saturated the market for $6 lattes. Starbucks will not see this trend turn around until consumers perceive value in their products. Currently they do not. For whatever reason, management still believes that their product is not a discretionary item and when things get tight, those items are the first to go.
This could be an easy fix for Donald. Instead of raising prices and further shrinking your market, lower them and expand it. SBUX raised prices twice last year and it just has resulted in less people coming in the door. I can't be the only one who sees this. Donald as much admitted this in an interview when he said that a July price increase of about $0.09 a cup hurt traffic. It is like sticking a fork in your eye and then wondering why it hurts.
Mr. Donald said Starbucks, like other retailers, is feeling the effects of pressures on consumer spending. Also, a sharp rise in dairy costs this summer caused the company to raise prices for the second time in less than a year. "We're seeing this economic impact not just in select states across the country but...coast to coast," he said. No kidding. If I were a shareholder I would really want to know why until late summer they were sticking to their 89 cents a share forecast and denying milk prices were an issue despite as my warnings as far back as May.
In the conference call I always go to the Q&A because it really tells you something about management, both in their candor what they are looking at. Starbucks CEO James Donald said at one point:
If all that is true, then why are people fleeing? Why are comps down at Starbucks but up at McDonalds (MCD)(I am just considering coffee) and Dunkin Donuts? What is happening out there is Donald sells a commodity that people are very price conscious to (despite his claims). That simply means that when given the option between comparable products, price and convenience win.
They are "trading up" as he says it but they are trading up to less expensive option. What Starbucks refused to admit it seems is that the competition has a quality product and it sells for far less. Also, does anyone really care about their "vertically" integrated operation? Some may, but not enough to keep the 20% EPS growth the company touts for next year.
CEO Donald responded this way to a question asking for an explanation of the negative traffic comps.
"I think that when we look at the softness in transactions, there’s a couple of things unfolding, and I mentioned them in my remarks. There are other operators in this specialty coffee business, but that doesn’t necessarily link in to this softness in comps. I think what you have to look at is just the pure and simple economic trends that we see."
He actually said other operators do not "necessarily link to this softness". Incredible. The only take away here is that he does not accept the simple FACT they are losing business to the competition. Are these folks just not drinking coffee anymore James? Staggering... Has he seen McDonald's numbers and transaction growth?
Even trading down 40% for the year to levels not seen since 2005, the stock still trades at 27 times current earnings and 22 times next years and if you believe they will hit the numbers they project next year, well, sorry.
Starbucks is still thinking like they are a little specialty niche operation and not the mega-chain they are. You cannot continue to growth a $16 billion dollar operation 20% a year by appealing to a smaller and smaller segment of the public. Especially when your competition (and yes James, McDonald's and Dunkin Donuts are your competition) have raised their game to match yours on several fronts.
EARNINGS
For the recent quarter ended Sept. 30, Starbucks posted net earnings of $158.5 million, or 21 cents a share, compared with $117.3 million, or 15 cents a share last year. Quarterly revenue was up to $2.44 billion from $2 billion last year. Analysts surveyed by Thomson Financial were projected 21 cents a share on $2.43 billion in revenue. Starbucks said it expects earnings per share in the next year of $1.02 to $1.05 a share, at the low end of the current $1.05 estimates.
For the full fiscal year, Starbucks earned $672.6 million, or 87 cents a share which was at the low end of the 87 cents to 89 cents the company predicted. It was not until July the company lowered expectations to the 87 cents a share.
The news that really mattered? A 1 percent drop in traffic, the first decrease since the company started releasing those numbers three years ago. CEO Jim Donald said the 1% dip in average transaction per store in the U.S., the first decline since Starbucks started disclosing this measure of customer traffic about three years ago, isn't a sign that the company has built stores too quickly or that the market is showing signs of saturation. "The saturation comment's overblown," he said.
For once I agree with Mr. Donald. Starbucks has not over-saturated the market with physical stores. What they have done is over-saturated the market for $6 lattes. Starbucks will not see this trend turn around until consumers perceive value in their products. Currently they do not. For whatever reason, management still believes that their product is not a discretionary item and when things get tight, those items are the first to go.
This could be an easy fix for Donald. Instead of raising prices and further shrinking your market, lower them and expand it. SBUX raised prices twice last year and it just has resulted in less people coming in the door. I can't be the only one who sees this. Donald as much admitted this in an interview when he said that a July price increase of about $0.09 a cup hurt traffic. It is like sticking a fork in your eye and then wondering why it hurts.
Mr. Donald said Starbucks, like other retailers, is feeling the effects of pressures on consumer spending. Also, a sharp rise in dairy costs this summer caused the company to raise prices for the second time in less than a year. "We're seeing this economic impact not just in select states across the country but...coast to coast," he said. No kidding. If I were a shareholder I would really want to know why until late summer they were sticking to their 89 cents a share forecast and denying milk prices were an issue despite as my warnings as far back as May.
In the conference call I always go to the Q&A because it really tells you something about management, both in their candor what they are looking at. Starbucks CEO James Donald said at one point:
Let me just add to that. When we examine the competitive landscape, I think one of the things that we have not done a very good job of, because we haven’t had to, is just examine and leverage the assets that the company has that’s meaningful to our customers.
As an example, most people that are entering the space and creating lots of noise are not coffee roasters. They don’t have 35 years of history and heritage around sourcing, buying, blending, and providing the customer with a fully comprehended, vertically integrated experience. That’s an asset that is very, very important to our customers and speaks to the quality, the loyalty, and the trust they have in Starbucks.
We have not really had to tell that story for many, many years because we haven’t been concerned about people trying to in any way create attrition for us.
The issue of competition I just want to address, is that we take it extremely, extremely seriously. We understand all too well that we have built a very attractive business for others to look at and try and take away, whether it’s 1% on the margin or big companies that are trying to take more. We are up for the defense and we are going to get on the offense.
I want to make it clear also that the size of the prize is so large and although I’ve said it so many times, I need to say it again; we have less than 10% share of the total coffee consumption market in North America and less than 1% in the world. As what has happened in many consumer products when there is new awareness, it creates a new trial among consumers who have not yet been in the category. That is taking place as we speak.
Those consumers over time are going to trade up. They are going to trade up because they are not going to be satisfied with the commoditized experience or the flavor. We will do everything we can to ensure the fact that when they trade up, they are trading up to the company that built the category and is the leader and that, ladies and gentlemen, is Starbucks. And you can be assured that we are deeply, passionately committed to preserving our leadership position.
If all that is true, then why are people fleeing? Why are comps down at Starbucks but up at McDonalds (MCD)(I am just considering coffee) and Dunkin Donuts? What is happening out there is Donald sells a commodity that people are very price conscious to (despite his claims). That simply means that when given the option between comparable products, price and convenience win.
They are "trading up" as he says it but they are trading up to less expensive option. What Starbucks refused to admit it seems is that the competition has a quality product and it sells for far less. Also, does anyone really care about their "vertically" integrated operation? Some may, but not enough to keep the 20% EPS growth the company touts for next year.
CEO Donald responded this way to a question asking for an explanation of the negative traffic comps.
"I think that when we look at the softness in transactions, there’s a couple of things unfolding, and I mentioned them in my remarks. There are other operators in this specialty coffee business, but that doesn’t necessarily link in to this softness in comps. I think what you have to look at is just the pure and simple economic trends that we see."
He actually said other operators do not "necessarily link to this softness". Incredible. The only take away here is that he does not accept the simple FACT they are losing business to the competition. Are these folks just not drinking coffee anymore James? Staggering... Has he seen McDonald's numbers and transaction growth?
Even trading down 40% for the year to levels not seen since 2005, the stock still trades at 27 times current earnings and 22 times next years and if you believe they will hit the numbers they project next year, well, sorry.
Starbucks is still thinking like they are a little specialty niche operation and not the mega-chain they are. You cannot continue to growth a $16 billion dollar operation 20% a year by appealing to a smaller and smaller segment of the public. Especially when your competition (and yes James, McDonald's and Dunkin Donuts are your competition) have raised their game to match yours on several fronts.
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This article has 3 comments:
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ejk
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1 Comment
Nov 19 10:00 AM-
shel1624
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Nov 23 11:31 AM-
shel1624
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Nov 23 12:09 PM