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Is Starbucks Nearing Its Demise?

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Starbucks (Nasdaq: SBUX  ) , Starbucks. That was one heck of a rotten quarterly earnings report. But let's take a deep breath, count to 10, and be frank -- who was expecting anything good, with all we've been able to glean about consumer spending in the last couple of months?

Ugly numbers
You have to scan the press release a little to get to the meat, since the subheads on it toss around words like "transitional," "re-architected," and "transformation." Of course, that all translates into "Things still stink right now."

Fourth-quarter net income plunged 96.6% to $5.4 million, or $0.01 per share. Nauseating. The quarter included about $0.09 per share in restructuring charges, which included charges related to store closures; back those charges out, and net income would have been $71 million, or $0.10 per share.

Revenues increased a relatively anemic 3% to $2.5 billion, and the 8% plunge in same-store sales is simply chilling when you remember the crazy comps growth Starbucks posted in yesteryears -- which seem increasingly far away at the moment. The explanation won't surprise anyone: deteriorating traffic trends and a decline in average value per transaction. Yep, sounds like a recession, all right.

Misery loves company
Returned CEO and founder Howard Schultz put a positive spin on things. He said recent transformational and architectural efforts position the company to drive earnings growth in fiscal 2009. He also said recent retail data shows that Starbucks may be faring a bit better than other high-end retail names. Schultz said October didn't yield a further deterioration in comps or traffic, and it's pretty much understood that October was terrible on the retail front, so let's hope that outlook holds. Schultz said he hoped the fourth quarter hit a "bottoming-out milestone."

After all, one could call this quarter "the quarter of terror," based on the litany of consumer-facing stocks that have had the wind knocked out of them from all of the macroeconomic punches. Whole Foods Market (Nasdaq: WFMI  ) and Bare Escentuals (Nasdaq: BARE  ) are two that I've covered recently.

Odds are good that many high-end, luxury brands will have a difficult time as excessive luxury tastes become a thing of the past for many consumers. For what it's worth, though, I think premium coffee is a different animal from the merchandise that companies such as Tiffany (NYSE: TIF  ) , Nordstrom (NYSE: JWN  ) , and lululemon athletica (Nasdaq: LULU  ) provide. Diamond jewelry, $1,000 boots, and expensive yoga togs all sound like good potential budget cuts to me, but we all still enjoy our coffee in the morning.

Still, I've noticed extreme pessimism about Starbucks' stock lately, and I've even run across comments from people who believe the company won't even make it out of this recession alive. In fact, Foolish readers voted it the scariest stock in our Halloween contest. That floors me. Good grief -- my nominee, Talbots (NYSE: TLB  ) , strikes me as far more terrifying, but that just goes to show how down on Starbucks folks are right now. I'm starting to wonder whether the pessimism can't get any worse.  

Figuring the future
I've often warned about companies that need to turn around their businesses and weather a consumer slowdown. It's a doubly difficult endeavor to do so. However, I have to say that Starbucks seems more likely to pull it off than many other retail names. I still believe it has an excellent brand, even if consumers aren't chugging as much of its coffees these days.

And even in these dreadful times, Schultz's comments about certain initiatives -- such as doubling Starbucks' fair-trade coffee purchases, to become the largest such purchaser in the world -- remind me why I believe in this stock. Even though people may be more focused on preserving their budgets than on socially responsible initiatives, these remain the types of actions that differentiate Starbucks' brand for the long term.

Starbucks gave several scenarios for earnings next year in its press release and said that in the worst-case scenario it outlined -- comps down 7% -- it still believes that it could report earnings of $0.59 per share in fiscal 2009. If consolidated comps fall by only 2%, it said it expects $0.78 per share in non-GAAP earnings in fiscal 2009.

Starbucks shares have plummeted by 56% in the last year. Its work is cut out for it, of course, and just how bad the consumer feels -- and for how long -- will be important. But if Starbucks does report $0.78 per share in earnings in fiscal 2009, it's trading at only about 13 times forward earnings. Look at Starbucks over the years, and you may remember a time when the thought of having Starbucks trade at such a low multiple would have seemed outlandish. In fact, MSN Money has its five-year high price-to-earnings ratio at 71. A bad year and a no-show turnaround will do that to you.

Whether you think Starbucks is cheap at these levels depends on whether you believe it can reignite its growth, learn its lessons, and still manage growth over the long term, even if it won't be as heady as it used to be. I believe it can. I think it's still a high-quality stock for the long haul, despite all of the current, bitter pessimism.  

Related Foolishness:

Whole Foods Market and Starbucks are Motley Fool Stock Advisor picks, and Starbucks has also been recommended by Motley Fool Inside Value. The Fool owns shares of Starbucks. Bare Escentuals has been recommended by both Motley Fool Hidden Gems and Motley Fool Rule Breakers. Try any of our Foolish newsletter services free for 30 days.

Alyce Lomax owns shares of Starbucks and Whole Foods Market. The Fool has a disclosure policy.

Read/Post Comments (19) | Recommend This Article (34)

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 November 11, 2008, at 4:55 PM, juliehowe wrote:

    Possibly. As a SBUX customer, these observations are troublesome to me.

    When I was at a SBUX in LA, using my free wi-fi, a message popped up on my screen, inviting me to 'get my free music download' because today was Tuesday and every Tuesday a new free song was available for download through Itunes.

    I went to the counter and the barista told me that their Starbucks location had quit participating in the program months ago, but suggested I try asking at another store. That store didn't have the 'free music Tuesday' cards either.

    Fast-forward a couple of weeks, and I happened to be in a remote and extremely rural area and popped in just to add $5 to my Starbucks card. They had the free music cards on prominent display next to the cash register.

    This was the first and only time that I ever actually got to take part in the promotion, even though the ad was prominent on the AT&T/Sbux wi-fi sign in page for months, and i fact, was still posted there until recently. So there is a disconnect somewhere and a small indication of what has gone wrong with the company, the brand and the whole Starbucks as a lifestyle idea.

  • Report this Comment On November 11, 2008, at 8:16 PM, swagv wrote:

    Starbucks wants so much to make us all believe that their problems are external rather than internal. Meanwhile, competitors are posting growth profits in Q2 & Q3 while Starbucks flounders (Peet's, etc.). How long do they expect us to play our sad-song violins in concert with the tragic economy opera before everyone notices that the quality competition is walking around with their pockets full?

    Schultz still wants to believe it's 1995 and Starbucks has cornered the market for quality coffee -- oblivious (or in denial) that the company he help build cut quality corners at every opportunity to sustain their massive expansion while better, more nimble entrants changed the marketplace in producing quality coffee products that justify the margins far more than Starbucks ever could.

    As long as Schultz still thinks its 1995 and they lead the quality game, the company is doomed. Their only salvation is if he has a come-to-Jesus moment and acknowledges Starbucks for what it has become in the marketplace today: a comfortable and ubiquitous place with decent coffee that now must compete in a sheer numbers game against major fast food competitors.

  • Report this Comment On November 11, 2008, at 9:05 PM, crappycoffee wrote:

    Anytime I had visited any Starbucks, the coffee was terrible and the place was a mess. I had wondered how long it would take for everyone else to open their eyes. Also, coffee at $5 a pop is extremely extravagant. In these times something has to give and obviously people have realized that the thing they can do without is a crappy cup of $5 coffee served in a nasty establishment. You guys really should have put more money into hiring more quality people and train them to deliver a great cup of coffee. Don't look for any bail out money for you, you need to fix it from the inside out.

  • Report this Comment On November 11, 2008, at 11:34 PM, HChickNZ wrote:

    I have to agree with CrappyCoffee - Starbucks coffee was DREADFUL. Instead of focusing on serving a good coffee product and having interesting sideline drinks, they deviated into all the frappe style drinks etc, and actually they do get tiring, as much as they are not the focus for any serious coffee drinker. Even their "novelty" coffees (Gingerbread lattes, and the like) were ghastly. There was very little resemblance to coffee of any sort.

    I also agree with CrappyCoffee that the cafes were usually filthy - I can think of one I have seen here in Auckland that was NOT habitually filthy, and crewed with students who didnt really understand how to make coffee, or care (with the exception of the odd one here and there who really served an ok coffee) and yes it is insulting getting swill thrown at you at an exorbetant price.

    I more or less ditched Starbucks back in 2005 with the odd exception here and there - generally if there was really NOTHING better.

    Guess the moral of the story is that they strayed too far away from what they should have made their main focus - COFFEE.

    Think its starting to look like RIP Starbucks huh.

  • Report this Comment On November 12, 2008, at 3:50 AM, nrkmann wrote:

    Hey! Starbucks depends on disposable income. In todays times of high unemployment, employment uncertainty, high fuel prices, etc. you same $100+ a month by not buying an AM coffee from any of the coffee vendors along the street. That $100 is needed by many folks for necessities.

    If you want that quality of coffee? Buy a Seco coffee maker (whole beans in one side, water in the other, and fresh coffee by the cup) and a travel cup for $500 and enjoy for years. We did that 10 years ago and believe my wife & I have saved about $20K over buying at the coffee shop every day, and have much better coffee... nrk

  • Report this Comment On November 12, 2008, at 9:23 AM, GriffyT wrote:

    Good comments, all, but at least in America, never bet against laziness (McDonald's is up these days) and above all, Never Bet Against Addiction.

  • Report this Comment On November 12, 2008, at 10:07 AM, webmasterGuru wrote:

    What a shame... What will I do without my cup of Java?

  • Report this Comment On November 12, 2008, at 2:57 PM, vmb63 wrote:

    Not sure how coffee that tastes and smells like mineral spirits got to where it did anyway. And at that cost to boot.....And what's wrong with Small, Medium and Large again?

  • Report this Comment On November 12, 2008, at 5:23 PM, artistx wrote:

    Demise? hardly. Down to earth? Definitely. With millions of loyal customers a day it's still one of the strongest brands going. They have definitely refocused on coffee and food that complements coffee. They also are focused on social and health issues (coffee prices, sourcing, healthier food options, etc.). All sectors have taken a hit and those that are doing well are the bargain basement brands (McDonalds, Walmart, etc.) This too shall pass once people get tired of being in the basement so to speak. It's easy to bash Starbucks but the evidence isn't there to back it up. Peets coffee isn't much different than Starbucks, it's only brand perception by a small, vocal minority (small guy is better). Odds are, with the number of customers that Starbucks has, you are more likely to hear from someone who had a bad experience. (1% of 100 stores won't generate the email like 1% of 20,000+ stores.)

  • Report this Comment On November 12, 2008, at 6:57 PM, FOOLBEFREE wrote:

    No bad experience for me. I buy coffee there everyday, and coffee beans every 2 weeks.

  • Report this Comment On November 12, 2008, at 8:30 PM, TexasLonghorns wrote:

    Take a look at the "MDP" porfolio and tell me folks are going to buy "Starbucks" the way they used to. Over leveraged Yuppies are eating their own cooking now. I suggested back in 08/08 that SBUX would see 10 before 20. May be five years before it does see 20 again, if they survive that long.

  • Report this Comment On November 13, 2008, at 6:47 AM, Ozcutty wrote:

    Had one Starbucks coffee in Brisbane, horrible watery, ridiculous cup size, never again. Plenty of better competition in Oz, Coffee club, gloria jeans, jamaica blue, maccas, donut king, wild bean cafe, michaels pattisere, a million other independent coffee shops.No wonder they are exiting the OZ market.

    Same experience in Uk where Costa Coffee is more popular.

    MF recommended at $20 = 26x next years earnings, are they mad? its already been cut in half and probably will be again.

  • Report this Comment On November 13, 2008, at 11:14 AM, NextStopParadise wrote:

    Aloha! When I first considered buying Starbucks, one day I walked into one outlet and what I saw was a crowd of late teens and 20-somethings hanging out and socializing over their lattes. At that moment I decided to buy, because if Starbucks attracts this young crowd now, they are likely to stick around for life. I see no shortage of customers, at least here on Oahu. Long live Starbucks! :)

  • Report this Comment On November 13, 2008, at 11:54 AM, CaptDLight wrote:

    Many folks get free refills and there by (no pun intended) get to hang out and mingle with the customers that do buy...

    In hard times addiction wins, but in REQLLY hard times addiction looses; so the fate of Starbucks is really dependent upon the level of the recession.

  • Report this Comment On November 14, 2008, at 5:08 PM, reggidmalc wrote:

    In the US Green Mountain Coffee Roasters and its category-winning Keurig single serve brewers are growing like crazy. You can brew about 25 different coffee blends incl flavored and decaf as well as many teas and cocoa and you can buy the K-cups in supermarkets and on the internet. At work you can put a machine in your cube or kitchen. Costs about $.50 a cup. Check it out on Google and check the stock out: GMCR. I own 3 Keurig brewers in our B&B and I own the stock.

  • Report this Comment On November 25, 2008, at 1:03 PM, coffeerules wrote:

    Great comments. I work for Starbucks 20 hrs a week in addition to a full time salaried position--totaling over 60 hours per week for me. I'm 37 and worried about my retirement. So I work. I work alongside much younger 20-somethings who rely on Starbucks as their sole wage to live and pay bills. My store is the top earning store in the Southeast region--we do $35,000 a week and more during the holidays. We earn over $1 million a year consistently. But the baristas make less than $8 an hour, and tips bring the wage to about $9 an hour on average. I once received a phone call just after we closed the store at 11pm from my District Manager--she wanted to know "the numbers." We had surpassed $10,000 in sales that day. She let out a celebratory scream that spoke volumes about the bonus she was expecting, while I had just worked an 8-hr shift, attempting to serve every customer a quality drink with a smile--for a day's earnings of $64. So here's my point: Starbucks is only as good as its baristas. Until the baristas are rewarded properly for their hard work, and until proper incentives are put in place to motivate hungry baristas, the quality and service will continue to decline, and customers will continue to abandon Starbucks for a better experience from the local coffee shops. Thanks for reading.

  • Report this Comment On November 29, 2008, at 11:00 AM, Almonte1 wrote:

    I am a fairly new investor, but I can think of a very good reason why most people just don't get the obvious about the US Economy. Step one: There is a fundamental flaw in pricing of all goods and services. Why:

    Businesses do not pay taxes, they simply act as a conduit. So if the corporate rate is 35%, the cost of something is already inflated by at least that percentage. The cost is sent to all rich or poor. If the individual tax rate is 15%, which is probably conservative, because you have to take into account Federal, state and local fees(taxes) then the cost of goods or services are inflated further, and the further you go up the tax latter(the more productive you are), the cost of items go up. The bottom line, in this scenario there is no mechanism to regulate cost downward, the cost continually go up. At some point supply and demand have little effect on pricing. Dah: Another enemy to us is OPM (Other People's Money). People get the idea we can solve the costs of things by letting others pay for them The trouble is we all pay for them. We are the other people.

    Wake up people, Governments like businesses never have nor will they ever have money of their own. Any money available to them comes from the people who buy their products or services. Make no mistake about this we are buying education, safety nets, investments(SSA), health care (Medicare and Medicaid) and other services from the US Government, and overall they are providing a substantially poor return on our investments I would argue we are getting a very good return on our protection services (Military). When our Uncle Sugar gets involved with loaning money to businesses and individual the true cost of things are further muddied and we end up with products and services that cost way beyond what they should. Recessions and depressions and businesses failing, foreclosure of homes, and our children receiving poor education and our elderly receiving poor return on their social security investments are the prices we pay for the current system. Seriously, the systems we developed for a basically regional economy need to be looked at in view of the global economy and adjusted accordingly. To quote Bob Dylan: The Times They Are A Changing. Correction Bob: The Times They Have Changed. It is time we do the same. I want to thank the Fools for some good advice and having this forum. Question: What should the price of X stock be if we took government involvement out? Einstein once said the hardest thing in the world to understand is income taxes!

  • Report this Comment On November 29, 2008, at 4:47 PM, fishita wrote:

    I hardly even drink coffee but have owned Starbucks stock for a few years now. I believe in the company's social values and commitment to investing in community projects. Also I value that they provide health insurance coverage even to part-time employees. I do cringe a bit when I read about the barista who only makes $9 an hour on average with tips but she should factor in her insurance benefits and realize what the company is putting out in insurance expense for all its employees. I don't think that people will give up Starbucks for Dunkin Donuts or McDonalds just based on price. There is obviously a different atmosphere from the moment one walks in the door. I get an inherently good feeling when I walk into a Starbucks that goes deeper than when I walk into a McDonalds for an egg mcmuffin. Starbucks tends to feed my soul as well as my thirst. I don't understand why people love to bash Starbucks. I think that its been going on for so long that it falls on deaf ears for the most part. I don't know if the stock will ever recover to where I bought into it years ago, but I sure hope so!

  • Report this Comment On December 04, 2008, at 12:39 PM, coffeerules wrote:

    I'd like to respond to the person who suggested I consider the health benefits that Starbucks provides. These benefits, as I'm sure you are aware, are not free. Now I ask you: How is a barista that makes $8 per hour supposed to offer a percentage of the paycheck toward health coverage? Not one single young person working as a barista for Starbucks can afford to buy the health coverage. So that's a carrot that doesn't make any sense to the little guys. BUT, if you are a spouse who doesn't need the money, only the health benefits--perfect. So unfortunately, Starbucks has indirectly (but intentionally) sought a certain demographic as its baristas--the spouse who has 20 hrs a week to devote to the company but doesn't really need the money, but DOES need the benfits because the significant other's employment does not offer this benefit. It's not working for the company, however, because the only people who really want to serve coffee to the masses are young people.

    So I'd just like to say, health benefits? For who? Again, Starbucks is only as good as its baristas -- the company needs to give them real financial incentives. Competitive wages create better workers, which feeds strong morale, which generates better service, which brings customers back, which generates profits.

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