Starbucks' New Drink
Plus, Innovex's review, AOL and Amazon
by Jeff Fischer
(JeffF@fool.com)

ALEXANDRIA, VA (July 14, 1998) -- "Fruity, icy, a bit of an edge. A good aftertaste. The tea is subtle. The fruit taste is strong and genuine. The chipped ice is refreshing. An excellent summer drink. $2.70 a pop. Not bad. So, does the Motley Fool reimburse me now?"

--a Fool on trying Starbucks juice tea

Yes, today I visited Starbucks (Nasdaq: SBUX) and slurped the new Mango Citrus Tiazzi Blended Juice Tea. Refreshing. Strong. "Titanic" icy. A delightful experience. This new tea, fruit and ice beverage launched on Saturday and employees claim that interest is strong. Starbucks offers free samples. The drink comes in Wild Berry or Mango Citrus, and though I haven't tried Wild Berry, I will. The Mango (which I didn't think I'd like) is actually quite good.

Starbucks has expanded its primary market by selling several inventive new coffee drinks, while Tiazzi is a step in expanding the tea market, too. On our Starbucks message board, I shared that, while lounging at Starbucks last week, I noted three-quarters of the patrons were buying Frappuccinos, a drink that Starbucks created. The beauty of this, of course, is that you can't get Frappuccinos elsewhere. Being able to create extra demand from a centuries-old commodity is no small task. People are accustomed to drinking coffee a certain way, and they're open to variations only if you have "the magic touch."

Another company creating extra demand in a centuries-old commodity is Amazon.com (Nasdaq: AMZN). The recent Washington Post article explains how. Amazon drives demand by offering ideas that you wouldn't otherwise find. Add to that the convenience of shopping from home anytime, day or night, and you have a sales-driving, demand-creating one-two punch. Perhaps more important than this, though, is the fact that many people actually find it fun to shop at Amazon. In recent literature the company describes itself as, "Amazon.com -- the place to read, listen, explore, and discover."

You can certainly discover things at Borders retail stores, too, but sometimes it's easier and quicker to find ideas online. There will always be a market for both online and off-line book sales, of course, but one sales model might prove stronger than the other. Either way, our money is on Amazon as the leader in the new model. (Borders has been a great investment for the Boring Port the past two years.)

Today the stock market delivered a one-two punch itself -- the S&P and Nasdaq both hit new highs. Chugging like a train from Boston to Maine, the Fool Port added 1.8% against a 1.0% gain in the S&P. America Online (NYSE: AOL) connected for a record high on news of a $15 million three-year deal with netgrocer.com. Sign on, check your email, and order your groceries. (The Roaring 2000s predicts that computers will track all your grocery orders and automatically reorder the items that you always need, say, every two weeks -- such as milk, eggs, and coffee. Those items will be delivered to your door, presto easy, without you having to think about it.)

AOL continues to make money as a gateway for businesses to the mass market. It owns key real estate. One common argument -- that I disagree with -- is that barriers to entry are incredibly low in the online world. In fact, though, a successful website is based on a community of regular contributors and readers, and building a lasting community actually portends incredibly high barriers to successful entry and survival. With books, for example, it's arguably easier to build a brick location (all it takes is money) compared to the hardship of building a website and maintaining a vibrant community when so many competitors lurk behind a single mouse-click. AOL earns numerous multi-million dollar deals because everyone wants the eyes and dollars of its stable community, while Amazon has a lead when it comes to community, too.

OK. Continuing down our list of stocks, today we look at Innovex.

 
    Innovex (Nasdaq: INVX) 
    Stock Price: $14 3/4 
    Market Cap: $220 million 
    Trailing Sales: $132 million 
    Price/Sales: 1.6 
    Last Qtr Sales: $25 million 
    Recent Gross Margin: 35% 
    Recent Operating Margin: 22% 
    5-year est. growth rate: 20% 
    P/E on far estimate: 9   
    Earnings Estimates: $1.12 in FY98 (ended Sept.) 
                                  $1.64 in FY99

What caused us to buy it? Innovex is a small company that leads its industry and has excellent profit margins. Like KLA-Tencor (Nadsaq: KLAC), the stock has had a strong decade, rising 43% annualized over the past five years alone. Again like KLA, though, it appears so far that the Fool Port bought "late." We bought Innovex, though, because we knew the company and because the disk drive industry was in a slump, thereby presenting a potential long-term opportunity to profit on the growth of the industry through a strong industry player. The Innovex buy report has details. Innovex commands 70% of its disk drive niche and has had 17% to 22% margins, and had a market-beating growth rate. It was trading at an attractive discount to that growth rate when we bought it.

What has happened since buying? Recognizing the cyclical nature of disk drives, we only sank $9,000 into this company, but that doesn't lessen the pain. To date, Innovex is the worst performer in the port, down over 45%. The industry's woes proved serious, and on top of that, Innovex is currently ramping to a new technology. Our company is in a battle with Hutchinson Technology (Nasdaq: HTCH), a battle that management thinks it can win by offering all the advantages of the competition at a lower price. Until orders for Innovex's new HIF technology increase, though, revenues will likely remain flat or decline and profit margins might continue to slip. It is a credit to the company, however, that it has remained profitable (one of the few disk drive firms to do so) during the past year of turmoil. Decreasing earnings estimates led to a lower stock price, but at least Innovex's balance sheet and shareholders equity have grown stronger.

What could cause us to sell it? With a book value of nearly $7 per share, Innovex's $14 stock doesn't seem very expensive. It trades at 10 times the earnings estimate fourteen months out (which is a guess), and the company aims to grow earnings 20% annually. With management moving to coinciding businesses (like semiconductor-packaging), a 20% growth rate could be very possible if the disk drive industry grows on par with PCs at about 14% annually. We will sell the stock if it ever appears that Innovex is losing a technology battle with competitors (I don't believe this is the case now -- INVX has the low cost solution); or if we find something better and need to raise money; or if Innovex can't find a way to grow earnings enough to merit a rising stock price. We'll also consider selling when the industry finally does rebound if we see a substantial and sustained rise in Innovex shares. Rebounds can be explosive.

The stock typically trades at around 14 times earnings, a discount to the long-term growth rate. If its P/E multiple expands in a better market, it might be time to cash-in our shares and look for a less cyclical company that's given more respect. Like semiconductors, the disk drive industry is a tough racket. We thought we were buying low, but it turns out we could have bought much lower. Now, in this strong stock market, Innovex and KLA-Tencor are almost like defensive investments -- they're already beaten into the ground. We don't have near-term plans to sell these stocks unless something changes or if we need money for a new idea. When a new idea arrives, selling our losers will likely be the first consideration.

AOL and Amazon.com

Because we didn't ask the above three questions when we reviewed AOL and Amazon last week, let's do so now.

What caused us to buy these companies? As you can read in the AOL and Amazon buy reports, both were leading a niche in a new but promising long-term high-growth industry.

What has happened since? Though facing increased competition, AOL emerged as the online service leader, with 55% market share. Internet service providers continue to provide competition, with MCI and Yahoo! and AT&T and Excite recently partnering to provide services. But the businesses of both AOL and Amazon are performing above expectations.

What would cause us to sell these companies? If either begins to lose its lead or sees its business takes a turn for the worst, then we would we consider selling. But we consider these very long-term investments -- being so risky, we especially bought these with a long-term outlook. Anything can happen near term. If the industries change radically and the companies fall behind, or if AOL begins to lose to Yahoo! and MCI in acquiring online accounts (I don't think that this will happen because most PCs ship with AOL software and AOL is the leading brand), or if Amazon begins to lose its community to a stronger community at Barnes & Noble online -- qualitative issues like this will make us reconsider the holdings. Or, as always, if we find something that we feel is better, we might sell some stock if we need to raise money.

Finally, International Paper (NYSE: IP) announced earnings that were a few pennies above the $0.26 estimate. The stock, which has lagged, burned a tad higher. We'll see earnings reports soon from several of our companies, including 3Dfx this week, Innovex, Iomega and others in the next fourteen days.

Fool on!

--Jeff Fischer

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07/14/98 Close

Stock Change Bid ---------------- AMZN +7 7/8 115.38 AOL +1 119.88 T + 5/8 57.38 DJT + 1/8 7.94 DD + 1/4 68.75 XON +1 9/16 72.06 INVX + 3/16 14.56 IP + 7/16 43.31 IOM - 1/4 5.56 KLAC -1 3/8 25.38 LU -1 1/2 87.94 SBUX - 3/4 56.75 COMS - 1/8 28.69 TDFX - 1/16 19.63
Day Month Year History Annualized FOOL +1.87% 7.80% 53.83% 416.27% 51.69% S&P: +1.06% 3.86% 21.35% 156.89% 27.06% NASDAQ: +0.15% 3.89% 25.35% 173.32% 29.07% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 119.88 3196.50% 9/9/97 580 Amazon.com 19.11 115.38 503.72% 5/17/95 1960 Iomega Cor 1.28 5.56 334.43% 10/1/96 84 LucentTech 23.81 87.94 269.36% 8/12/96 130 AT&T 39.58 57.38 44.97% 2/20/98 215 DuPont 59.83 68.75 14.90% 2/20/98 200 Exxon 64.09 72.06 12.44% 4/30/97 -1170*Trump* 8.47 7.94 6.27% 7/2/98 235 Starbucks 55.91 56.75 1.50% 2/20/98 270 Int'l Pape 47.69 43.31 -9.18% 1/8/98 425 3Dfx 25.67 19.63 -23.54% 8/13/96 250 3Com Corp. 46.86 28.69 -38.79% 8/24/95 130 KLA-Tencor 44.71 25.38 -43.25% 6/26/97 325 Innovex 27.71 14.56 -47.45% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 85111.25 $82529.38 9/9/97 580 Amazon.com 11084.24 66917.50 $55833.26 5/17/95 1960 Iomega Cor 2509.60 10902.50 $8392.90 10/1/96 84 LucentTech 1999.88 7386.75 $5386.87 8/12/96 130 AT&T 5145.11 7458.75 $2313.64 2/20/98 215 DuPont 12864.25 14781.25 $1917.00 2/20/98 200 Exxon 12818.00 14412.50 $1594.50 4/30/97 -1170*Trump* -9908.50 -9286.88 $621.63 7/2/98 235 Starbucks 13138.63 13336.25 $197.63 2/20/98 270 Int'l Pape 12876.75 11694.38 -$1182.38 8/24/95 130 KLA-Tencor 5812.49 3298.75 -$2513.74 1/8/98 425 3Dfx 10908.63 8340.63 -$2568.00 6/26/97 325 Innovex 9005.62 4732.81 -$4272.81 8/13/96 250 3Com Corp. 11715.99 7171.88 -$4544.12 CASH $11876.47 TOTAL $258134.78

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