Starbucks Goes Decaf?
You be the judge. Plus, week's roundup.
by Jeff Fischer

ALEXANDRIA, VA (July 24, 1998) -- The Fool beat the S&P this week, though not with numbers that we'll be talking about this weekend at the Fool softball game. (Go Fools! The Fool softball team has gone from absolutely last place in 1997 to tied for first place this year, with 9 wins and 2 loses. This record compares to a big "0" in the win column last year. Now that's a turnaround!)

Over the past five days the portfolio fell 3.75% against the S&P's 3.87% decline. Nasdaq lost 3.87% as well -- exactly. (Coincidence? You be the judge.) gained $4 over the past week, but other than that it was ugly, with the ugliness spreading to 3Dfx, 3Com, and DuPont. But Starbucks is the big story of the day.

On Thursday, both Starbucks (Nasdaq: SBUX) and AT&T reported numbers. AT&T has only risen since, while Starbucks first went cold, then flat, then spilled over the counter and pooled on the floor. The reaction of the market probably surprises the company as much as it does me. Starbucks reported strength across the board and the conference call was upbeat -- the next five years should be great.

But management guided analysts to the low-end of the earnings estimates for next year, and that -- a matter of pennies -- sent the stock reeling. Despite the fact that Starbucks still plans to hit the range of estimates and grow earnings 35% as expected, the stock dropped $7 1/2, or 13%. Perhaps the market was hoping that Starbucks would beat earnings estimates all of next year, because admitting that you'll meet the range of analyst estimates in the year ahead, even to the low end, rarely sends a great brand leader to the cleaners. Or if it does, it doesn't for long. Category brand leaders bounce back more readily than others.

Let's consider the earnings numbers.

In the conference call, management said it is targeting earnings for fiscal 1999 of $1.20 to $1.25 per share. The current analyst estimate is $1.24 per share, with estimates ranging from $1.17 to $1.30. Starbucks is clearly growing within the range of 1999 estimates. Next up, for the fiscal year that ends in one quarter, management expects $0.89 to $0.94 in earnings per share. The current published estimate is $0.93, with analysts ranging from $0.90 to $0.97.

Okay, here Starbucks might miss the low-end of the '98 estimates by one penny (but then again, there's even the possibility of the company beating the published estimate by a penny). Either way, this fiscal year is almost over anyway. A penny here or a penny there isn't going to break the company's great 1998 performance. It's just about history.

Following the Starbucks conference call, one analyst at BT Alex. Brown rationally lowered his estimates by one penny for this year and five cents for next year, to $1.25 per share in 1999 from $1.30 (remember the range was $1.17 to $1.30, so yep, he had the highest estimate for next year anyway). And the analyst kept his "strong buy" rating on the stock and maintains a $101 twelve-month price target. He sees -- as do some Fools -- a powerful global brand that is capable of $10 billion in annual sales in the years ahead, up from the current $1 billion.

Indeed, the conference call has interesting facts such as, "Starbucks has less than 5% market share of the U.S. coffee industry." And don't even mention Starbucks' international market share -- it's well below 1%. Other information in the call included the fact that the average Starbucks customer visits a store 18 times per month, and that Starbucks serves 7 million people per week in nine countries.

Yet, this company is truly just beginning its business. Starbucks has been public for six years -- it's young, young, young. And yesterday, like Microsoft, Starbucks warned everyone to err to the conservative side for next year's earnings. That's a smart move -- management should always err to the convservative. But unlike Microsoft, this stock got hammered. The business is strong and growing, though, and I'm glad that the Fool Port is aboard for the coming years. I wish that we'd bought after this decline, but in the long run that's neither here nor there. In fact, it borders on Wise to even say it.

At $48, Starbucks trades at 40 times the low earnings estimate given by management for 1999, five quarters out, of $1.20 per share. Earnings should grow 35% next year, so arguably the leading coffee retailer in the country is trading at a forward P/E multiple very close to its growth rate. Our coffee guy trades at just a slight premium to a fairly certain (and conservative?) earnings number for 1999.

By the way, this obsession with pennies and yearly earnings growth seems to have intelligently subsided with investors in giant leaders like Coca-Cola (NYSE: KO), a stock that continues to make new highs in the face of a year of flat earnings. Coke rises anyway because its shareholders equity is still growing, and the company is still the powerful brand that it always was. Plus, earnings will grow again in the future.

Eventually companies trade more on overall market value and brand value and especially on long-term cash generation, rather than on pennies and short-term earnings growth rates. Starbucks is apparently still "too hot" to merit such stability in the share price. It's still considered a fast grower, and many investors want juiced up earnings and have no mercy with any sort of letdown. (These kinds of investors are the ones who never leave even a penny in the tip jar when they buy a coffee.)

Starbucks hasn't gone decaf on us, it's still energetically growing earnings 35% next year, as expected. In fact, this admission by management might actually be music to some ears -- 35% sounded like heady growth for a company with over $1 billion in sales. Good to see that Starbucks should actually pull it off in '99.

To wrap up...

Six Fool Port stocks reported earnings this week. On Tuesday, we focused on results from Innovex and reviewed our thoughts on Iomega. On Wednesday, and Lucent Technologies shared quarterly results, as did DuPont. Only DuPont disappointed, as we shared in Wednesday's column. Thursday, again, we wrote about Starbucks and AT&T.

The conference calls for several of our companies are now available, including Innovex, Starbucks, Lucent, and from last week Iomega (and Intel and recent others are available in the conference call area, too).

Have a Foolish weekend!

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07/24/98 Close

Stock Change Bid ---------------- AMZN - 3 124.25 AOL -6 5/16 119.19 T +1 5/16 59.88 DJT - 1/8 7.13 DD + 1/16 61.00 XON + 1/4 70.38 INVX - 7/16 14.25 IP - 1/2 43.50 IOM --- 5.56 KLAC + 11/16 26.63 LU + 15/16 96.19 SBUX -7 9/16 47.81 COMS - 5/8 26.94 TDFX - 11/16 14.38
Day Month Year History Annualized FOOL -3.07% 7.78% 53.81% 416.20% 51.24% S&P: +0.09% 0.61% 17.56% 148.87% 25.84% NASDAQ: -0.21% 1.92% 22.97% 168.14% 28.23% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 119.19 3177.59% 9/9/97 580 19.11 124.25 550.16% 5/17/95 1960 Iomega Cor 1.28 5.56 334.43% 10/1/96 84 LucentTech 23.81 96.19 304.01% 8/12/96 130 AT&T 39.58 59.88 51.28% 4/30/97 -1170*Trump* 8.47 7.13 15.87% 2/20/98 200 Exxon 64.09 70.38 9.81% 2/20/98 215 DuPont 59.83 61.00 1.95% 2/20/98 270 Int'l Pape 47.69 43.50 -8.79% 7/2/98 235 Starbucks 55.91 47.81 -14.48% 8/24/95 130 KLA-Tencor 44.71 26.63 -40.45% 8/13/96 250 3Com Corp. 46.86 26.94 -42.52% 1/8/98 425 3Dfx 25.67 14.38 -44.00% 6/26/97 325 Innovex 27.71 14.25 -48.57% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 84623.13 $82041.26 9/9/97 580 11084.24 72065.00 $60980.76 5/17/95 1960 Iomega Cor 2509.60 10902.50 $8392.90 10/1/96 84 LucentTech 1999.88 8079.75 $6079.87 8/12/96 130 AT&T 5145.11 7783.75 $2638.64 4/30/97 -1170*Trump* -9908.50 -8336.25 $1572.25 2/20/98 200 Exxon 12818.00 14075.00 $1257.00 2/20/98 215 DuPont 12864.25 13115.00 $250.75 2/20/98 270 Int'l Pape 12876.75 11745.00 -$1131.75 7/2/98 235 Starbucks 13138.63 11235.94 -$1902.69 8/24/95 130 KLA-Tencor 5812.49 3461.25 -$2351.24 6/26/97 325 Innovex 9005.62 4631.25 -$4374.37 1/8/98 425 3Dfx 10908.63 6109.38 -$4799.25 8/13/96 250 3Com Corp. 11715.99 6734.38 -$4981.62 CASH $11876.47 TOTAL $258101.53

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