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Starbucks: Grounds for Exuberance?

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Judging by the stock's jump today, many investors enjoyed a serious espresso buzz after Starbucks (Nasdaq: SBUX  ) reported a better-than-expected profit in its third quarter. But the java giant can't simply rest on its laurels if it wants to regain its luster.

Starbucks' net income came in at $151.5 million, or $0.20 per share. Analysts had expected earnings of $0.19 per share. Last year this time, Starbucks had reported a third-quarter loss of $6.7 million, or $0.01 per share, so the company is certainly moving in the right direction.

However, Starbucks' quarterly profit owed greatly to cost-cutting, since customer traffic was still lackluster. Sales fell 6.6%, to $2.40 billion, and same-store sales dropped by 5%. Starbucks' traffic trends improved from last quarter's 8% decline, but the 5% comps decrease it posted this time around remains far from inspiring.

The ugly economic environment is making life tough for Starbucks, even as champions of cheap such as McDonald's (NYSE: MCD  ) and Wal-Mart Stores (NYSE: WMT  ) thrive. The pricey coffee that seemed like an affordable luxury in better times is now easy for customers to slash from their daily expenditures.

Unfortunately, the customer-focused initiatives Starbucks has been testing to reverse this slump may risk tarnishing its brand, especially as it struggles to compete with McDonald's and more similar rivals Peet's Coffee and Tea (Nasdaq: PEET  ) and Caribou Coffee (Nasdaq: CBOU  ) . Starbucks, which historically never had to rely on advertising at all, has started print ad campaigns -- another reason to wonder whether the java giant has lost its sheen. At least Facebook still loves Starbucks; the company has the most popular brand page on the hot social networking site, according to The Wall Street Journal.

As a shareholder, I can't say I'm dismayed to see the stock up more than 17% the last time I checked. Still, investors might want to temper their caffeinated euphoria, especially when sales could still use a jolt. I'm still hanging on to the stock, but I can't underestimate the challenges the company faces. The frothy economic environment that helped Starbucks brew up so much of its previous success has been drained to its last dregs, and the company faces much grittier times ahead.

Pour yourself some related caffeinated Foolishness:

Starbucks has been recommended by both Motley Fool Stock Advisor and Motley Fool Inside Value; Wal-Mart is also an Inside Value pick. The Fool owns shares of Starbucks.

Alyce Lomax owns shares of Starbucks. The Fool has a disclosure policy.

Read/Post Comments (4) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 22, 2009, at 3:29 PM, wolfhounds wrote:

    SBUX is having the same problem as most retailers - falling same store sales. A 5% drop this quarter is reason for concern given all the measures taken to date.

  • Report this Comment On July 22, 2009, at 6:06 PM, alexreising wrote:

    Anyone out there thinking of shorting SBUX? I'm seriously contemplating it, it's current valuation is totally unsustainable in my opinion, but I'm not sure I'm ready to commit real money just yet.... thouhgts?

  • Report this Comment On July 23, 2009, at 1:57 PM, Gregeph wrote:

    I cannot predict whether the shares of Starbucks will be higher in the short term. On a long-term basis, I have some concerns about its valuation. At $17 per share, it is selling at 19.5x peak earnings of $.87 and 27x its five year average EPS of $.62. In addition, the U.S. is increasingly a mature market for Starbucks and in fiscal 2008 they relied on the U.S. for 76% of their revenue. Domestic growth is going to be challenging with a struggling U.S. economy. McDonalds’ aggressive push into coffee may have an effect on Starbucks which is greater than zero. Increased competition and a weak economy will make it difficult for Starbucks to raise prices. An inflationary increase in commodity prices could impact margins. It is unclear if international expansion can meet the market’s expectations for growth. As of the end of the 2008 fiscal year, the company already had 1,979 company-operated international stores and 3,134 licensed international stores. In the 2008 Annual Report, the company acknowledges its increasing dependence on the international operating segment and that occupancy and operating costs can be higher in international markets. The international segment only produced $110 million in operating income in 2008. This number reflects $19.2 million in restructuring costs due to 61 store closings in Australia.

  • Report this Comment On July 24, 2009, at 12:29 PM, DBrown7 wrote:

    Be very careful about shorting a stock based on valuation alone. If you believe that SBUX is also a deteriorating business going forward, then that makes a better case for taking a short position.

    Many have shorted stocks based on valuation alone and paid dearly. I can think of one former Fool employee and now recent Fool employee again recommending shorting AMZN while writing for another newsletter. It made perfect sense based on valuation alone (still does). He finally rec'd covering the short several months later at a significantly higher price. He vowed never again to short a stock based on valuation alone.

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