The Worst Stocks for 2010: Starbucks

Starbucks (Nasdaq: SBUX  ) investors were rewarded during 2009. The coffee king more than doubled -- and proved my Foolish colleague Alyce Lomax prescient.

"With Starbucks' shares so beaten down right now, investors might just regret not snapping them up at such bargain prices," she wrote last year at this time.

The caffeine comedown
Fools don't have nearly as much to cheer about now. True, Starbucks is expected to see a heady burst of growth during 2010, and yesterday's earnings report showed a nice improvement, but that's already largely priced into the company's caffeinated price-to-earnings multiple, as illustrated in the table below:

Date

Closing P/E*

Following Year's Earnings Growth*

1-Year Return

Dec. 31, 2009

30.7

28% (est.)

0.9%**

Dec. 31, 2008

15.2

60.8% (est.)

134.3%

Dec. 31, 2007

23.9

(42.4%)

(51%)

Dec. 29, 2006

49.8

10.6%

(41.9%)

Dec. 30, 2005

49.1

12.6%

14.7%

Sources: Capital IQ (a division of Standard & Poor's), Yahoo! Finance.
* On a normalized basis, per Capital IQ.
** Year-to-date return.

For reference, this table shows (a) the closing price-to-earnings ratio from the prior year, (b) the following year's earnings growth, and (c) commensurate stock return.

Starbucks had its best year when it was priced cheaply. Now, with the coffee king fetching around 30 times normalized earnings, I sense that it's priced for mediocre returns at best. And I'm not the only one. Let's check in with Motley Fool CAPS.

Metric

Starbucks

CAPS stars (out of 5)

**

Total ratings

7,299

Percent bulls

76.5%

Percent bears

23.5%

Bullish pitches

1,208 out of 1,665

Data current as of Jan.20.

"Will find tough competition from many other sources, with no newer markets welcoming them," wrote CAPS investor offtheboard in December.

In this case, competition comes not only from Green Mountain Coffee Roasters (Nasdaq: GMCR  ) and Peet's Coffee & Tea (Nasdaq: PEET  ) but also from fast-food joints trying to go upscale. McDonald's (NYSE: MCD  ) is the best and most visible example.

But it's actually worse than that
Starbucks isn't the destination it used to be. Instead, it's following the same pattern as Barnes & Noble. Yeah, B&N and online options such as Amazon.com (Nasdaq: AMZN  ) have taken a toll on local independent bookstores around the country, but the indies' rate of decline has slowed remarkably. More than 350 new indies have opened since 2005, The Boston Globe reports, and increasingly customers are seeing the value of the independents. That's a pattern that Starbucks must be wary of in its own industry.

Now look at Starbucks:

Fiscal Year

Store Count

Growth Rate

2009

16,635

(0.3%)

2008

16,680

11.1%

2007

15,011

20.7%

2006

12,440

21.5%

2005

10,241*

52.2%

Source: Company SEC filings.
*Up from 6,730 at the close of fiscal 2004.

So Starbucks' expansion has slowed remarkably of late. But wait, it gets worse.

"Of the 300 net new stores [to be opened during fiscal 2010], we expect approximately 100 to be in the U.S., primarily licensed, and approximately 200 to be in our international markets, also primarily licensed," said Chief Financial Officer Troy Alstead during the last earnings conference call.

In other words, the majority of new store growth will come from licensees this year.You know what percentage of Starbucks stores were company-owned, as opposed to licensed, during 2005? More than 58%. The percentage as of September 2009, the close of the fiscal year? Just over 53%. In other words, Starbucks is increasingly outsourcing growth through licenses and letting others take on some of the financial risk of operating a store.

Meanwhile, there are still at least 2,160 independent coffee shops operating in 991 U.S. cities, the website indiecoffeeshops.com reports.

Why some loyalists might make the switch
It's a dangerous time for Starbucks, which had recently suffered not just lower revenue and a shrinking store count but also compressed margins. Wednesday's quarterly earnings report changed that a bit, though, showing 4% higher year-over-year revenue and much improved margins.

No doubt that's a reflection of the company's attempt to address all three issues, but one customer-reward program might cause more harm than good -- My Starbucks Rewards. Why? Some loyalists don't like it. One I quoted here did the math to show how he'd lose out under the new program, when compared to an earlier Gold Card program that offered regulars like him a 10% discount:

This is a total step down for current Gold Card members. Assume someone goes every morning, at $4 a trip. After 15 stars they've spent $60 and will get a coupon worth $4, a 6.6% savings. The new program will be an improvement for the guy getting a daily drip coffee if he spends that coupon on a latte, but definitely not for the super regulars. Starbucks needs to add a third level to the program for super regulars – 50 stars? – and bring back the 10% discount.

A Starbucks spokesperson I talked with last week took issue with this customer's math, saying he hadn't factored in a free birthday drink and the $25 annual fee Gold Card members had been paying.

I think that's a fair point, so I redid the math to factor in these benefits and found Gold Card members would still take home $21 more in savings. My Starbucks Rewards appears to reward Starbucks more than it does its best customers. Interestingly, the spokesperson acknowledged this in an interview.

"We acknowledge that some customers won't benefit as much under the new program," she said. "[But] we believe this is a superior program that appeals to a broader base of customers."

Really?
At least some Gold Card members think otherwise, and Starbucks can't afford to see its big spenders spend elsewhere -- especially when the value of sitting at Starbucks for work and Wi-Fi has become muted in the age of connected libraries and fast, high-function smartphones from Apple (Nasdaq: AAPL  ) and Research In Motion (Nasdaq: RIMM  ) .

Buying into a cheap stock whose competitive advantage is weakening is dangerous. Buying into an expensive stock whose competitive advantage is weakening is stupid. Starbucks is weaker and more expensive than it was a year ago.

What do you think is the worst stock for 2010? See the rest of our contenders and cast your vote!

Amazon, Apple, and Starbucks are Motley Fool Stock Advisor selections. Green Mountain Coffee Roasters is a Motley Fool Rule Breakers recommendation. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the market-beating Rule Breakers stock-picking team. He had stock and options positions in Apple at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. The Motley Fool is also on Twitter as @TheMotleyFool. The Fool's disclosure policy has a not-so-little case of Wii tennis elbow.


Read/Post Comments (2) | Recommend This Article (9)

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 January 21, 2010, at 3:24 PM, ozzfan1317 wrote:

    Mcdonalds isnt really that much competition the product they are selling is by GMCR so really its just another place that GMCR is being sold.

  • Report this Comment On January 21, 2010, at 6:09 PM, baldheadeddork wrote:

    Gotta disagree with you on this one, Tim. I don't think SBUX is going to be a growth stock, but it has survived its initial overexpansion, the correction, and then the meltdown of 2008-2009.

    Shifting to licensees (as long as it's done smartly) is a very smart way to grow sales and reach new markets without incurring startup costs. About the customer rewards program, getting rid of anything that had a $25 annual fee is going to make it a lot more attractive to a lot more people. The daily customers aren't going to change over a few cents per cup over a year unless there is a local place that is equally convenient, fast and has the flavor a Starbucks customer is looking for.

    I think Dunkin Donuts is a more formidable challenger to SBUX than MCD, but they have their own problems. McDonald's finally having a palatable cup of coffee isn't going to fix problems with much slower service than Starbucks and a much less appealing store environment.

Add your comment.

DocumentId: 1090143, ~/Articles/ArticleHandler.aspx, 7/26/2014 11:10:55 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement