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Worst Stock for 2008: Starbucks

Resolve to keep your portfolio healthy: Help us pick the worst stock for 2008.

"Some people even call our stores sterile, cookie-cutter, no longer reflecting the passion our partners feel about our coffee. In fact, I am not sure people today even know we are roasting coffee. You certainly can't get the message from being in our stores."

-- Howard Schultz, Feb. 14, 2007

Since Starbucks (Nasdaq: SBUX  ) founder Howard Schultz's infamous memo was leaked, Starbucks shares have lost about 40% of their value. As a Starbucks shareholder, I should have taken Schultz's words more seriously.

Though I was excited to hear Schultz is returning to his old CEO position, I'm still convinced that 2008 is going to be a bleak year for Starbucks.

Why? First, there are those pesky rising food prices -- particularly milk -- that adversely affect Starbucks' margins. Then there are concerns about labor unions infiltrating the company's rank and file. But, most importantly, a lot of damage has been done to the brand since Schultz stepped down as CEO in 2000, and that will take some time to fix.

Among other things, Schultz must address two other major issues this year, including:

Diminished competitive advantages
Sure, early Starbucks investors have made a ton of money on their investment. And yes, Starbucks was the first-mover in bringing the gourmet coffee experience to the U.S. on a mass scale. Unfortunately, the days of earning 1,000% in a ten-year period for this stock are likely over.

Not only is Starbucks getting too big to repeat that performance, but whenever there are high margins to be made in an industry with relatively low barriers to entry, competitors inevitably arrive.

And, slowly but surely, competitors like Dunkin' Donuts, McDonald's (NYSE: MCD  ) , Peet's Coffee (Nasdaq: PEET  ) , Caribou Coffee, and even local coffeehouses have eaten away at Starbucks' competitive advantages, specifically its image as a "third place" for consumers outside of home and work. Moreover, each company challenges Starbucks in a unique way, whether it be price (McDonald's), quality (Peet's), image (Caribou), or pretentiousness (Dunkin' Donuts).

Watered down experience
According to Schultz's 1997 book Pour Your Heart Into It, franchising was "almost a forbidden word to Starbucks." "We refused to franchise," Schultz said, "Although it would have been tempting to share costs with franchisees, I didn't want to risk losing control of the all-important link to the consumer."

Ironically enough, just one year later, Starbucks introduced its first "licensed" location at Albertson's grocery stores. Even though licensed locations in stores such as Target (NYSE: TGT  ) and Safeway (NYSE: SWY  ) helped Starbucks expand and kept financial costs down over the past decade, the initiative may end up costing the company brand value in the long run. These locations, after all, are not the typical Starbucks "third place," but simply "refueling stations" for sluggish shoppers who need a caffeine boost before spending money.

I wanna be like Mike
In sum, Schultz has a lot of work to do, so don't expect miracles over the next year. On the bright side, it did take Michael Jordan a full season to return the Bulls to championship caliber after his first comeback. Likewise, I believe Schultz is a superstar leader and can steer Starbucks onto the right path once again. It just won't be this year.

What do you think? You can make your voice heard on Motley Fool CAPS right now, where more than 80,000 other investors are waiting to hear what you have to say. To rate Starbucks and explain your investment thesis, head to CAPS.

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5/25/2016 1:07 PM
SBUX $55.23 Down -0.22 -0.39%
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MCD $123.19 Down -0.76 -0.61%
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